The Chartered Valuer and Appraiser Program: Introductory Business Valuation Level 1

Topic 1: Business Valuation – What, Why, How and for Whom?

 Business valuation is the process of ascertaining the worth of an asset or a liability; it can be an entire business, the
ownership interest in the business, or a particular asset or liability of the business.
 IVS 2021: The act or process of determining an opinion or conclusion of value of an asset on a stated basis of value
at a specified date in compliance with IVS.
 Valuation is a combination of both science and art. The “science” aspect involves a systematic application of a body
of well-established theories in deriving the value. These theories rest on an assumption of rational behaviour of
investors and an assumption of the objective of a business, whereas in practice, human nature and the roles of
businesses are much more complex. Thus, the “art” perspective involves using subjective judgement to the
particular circumstances in applying the theoretical model in valuation.

Basic Principles

 An economic benefit that commonly surfaces in business valuation is cash flows. Hence, the value of the asset must
be linked to the total future cash flows we expect it to generate. The basic idea behind business valuation is to
estimate the worth of cash flows expected from it. The value is estimated based on current available information of
the asset to the valuer.
 Value is as good as the information available to the valuer . Valuers can derive a different value of the business or
asset if they possess different sets of information.
 Value is time dependent. The value of a business or asset changes over time as relevant new information arrives.
 In the case when a valuer is engaged to provide an opinion on the value of a business, the valuer will need to first
determine the valuation date. The valuation date is the specific point in time as of which the valuer’s opinion of
value applies. The valuer should only consider all factors known up to that point in time in forming the assessment
of value.
 Retrospective evidence, such as data or information, is not admissible in reaching an assessment of value at a
specific point in time. This principle forbids the application of hindsight evidence unless these facts would
reasonably have been known or knowable at the valuation date. Foreseeable subsequent events are not good
enough to be considered. The business valuer cannot use hindsight in actual value determination.
 Value is purpose dependent. The value of a business or an asset can differ because the objectives of the valuation
are different.
 Value is not objective. Even if the purpose of the valuation exercise and the valuation models used are similar, the
value derived can still differ. This is because subjective judgements are often required in selecting the inputs for the
valuation models.
 Value and current market price are not necessarily the same . For those who believe that markets are efficient, the
market price is therefore the best estimate of value. However, it is possible that at times the market price of a
business or asset may deviate from the value of the cash flows it is expected to generate. The deviation may be
because of market error, or information that is not available to general market participants at that point in time, or
due to temporary irrational market behaviors by investors, or the current market price pertains to a small amount of
shares and, thus, may reflect the value to minority shareholders only.
 Value is built around the concept of risk and return . As it is, the current value of any asset is related to its expected
future returns. As no one can accurately predict the future, there is always uncertainty to such future returns. The
higher the level of uncertainty, the riskier the asset. Putting this in simple financial terms, the current value of any
asset is equal to the present value of the future returns generated by the asset. Often, the future returns of the
asset are represented by the future net cash flows which are discounted to present value by an appropriate rate.
The more uncertain (risky) the future net cash flows, the higher the rate used to discount it.
 Value relates to expected future returns . This principle emphasizes that it is the future economic benefit that a
company can potentially generate that drives value, and that past history is often irrelevant except for the fact that
it may serve to provide an indication as to the plausibility of the future projections of the company.
 From a practical application standpoint, a key challenge to this principle often revolves around the reasonableness
of the assumptions used by a company in projecting future returns and the quality and reliability of such forecasts.
Historical information can be a helpful guide to future prospects. The availability of quality historical information will
enable the business valuer to better identify and assess the assumptions that underlie the forecasts.
 Liquidity affects value. The higher the number of prospective purchasers of the business, the greater will be its
value. This is so as the price for a business is likely to be higher when there is more than one prospective buyer. This
is often the case as the seller of the business is typically in an improved position for negotiation.
 The value of a minority interest may be worth less than the value of a controlling interest . The benefits commonly
associated with control could include the ability to: Control the board of directors; Influence business strategy and
operations; Appoint and remove management of the company; Access financial information and other information
required for decision making; Acquire and dispose of assets and businesses within the company; Change financial
and operating policies of the company; and Access the company’s cash flows, and dictate the timing and quantum of
the return on investment, etc. These benefits do not accrue to minority shareholders. When the business valuer
determines the value of a minority interest, these factors often result in the application of minority discounts from
what otherwise would be the controlling value.
 Value and cost are not necessarily the same. Cost is the amount required to acquire an asset and when that
happens, it becomes something of a fact. Value, on the other hand, relates to an opinion of what should be the price
to be paid for an asset or the economic benefits of owning the asset.