WHY VALUE A COMPANY ?. To make decisions about…:
- Acquisitions or sales of companies Mergers Establishment of purchase agreements Capitalization of a company Valuation of intangible assets (goodwill) Obtaining lines of financing Equity valuations Tax valuations Purchase and sale of shares Inheritances Confirmation of other valuations. “Second opinion” Valuation of minority share packages Suspensions of payments.
The valuation of a company can help answer questions such as:
- How much is my business worth? What has been the return on investment of my business? What can be done to improve this profitability and create wealth?
HOW MUCH IS MY COMPANY OR BUSINESS WORTH?
In the business world there is a very important question whose answer generates all kinds of opinions because it involves a series of internal and external factors, tangible and intangible, economic, social, technological, productive, labor, legal, market and it is '' HOW MUCH IS MY COMPANY WORTH? ''
The commercial value of a business must determine in any situation but it is essential in certain cases such as entry or withdrawal of partners of entities not registered in the stock market and in general, in sales transactions: in the evaluation of the management of the management when the basic objective of the owners is to maximize the value that the company has for them; in the analysis and interpretation of the financial situation of the business and when analyzing the effort when starting a business a company.
To give value to a business, quantitative and qualitative elements can be used, starting from those quantifiable such as the balance sheet, income statement, information on income projection and costs. The accounting information has the characteristic of grouping accounts whose figures are a combination of past, present and future; therefore the resulting amount cannot be the commercial value of the company.
So if the accounting information system does not actually say how much a business is worth, how can it be determined? A business is worth for its ability to generate future profits (Good-Will) in addition to what it owns at a given time, that is, a business is worth for its net assets plus the present value of its future profits.
The process that must be followed to determine the commercial value of a company is as follows:
NET ASSET VALUE:
It consists of finding the commercial value of the healthy assets and subtracting the value of the adjusted liabilities.
With regard to the healthy assets, each of the accounts should be analyzed bearing in mind these observations:
CASH AND BANKS: The amount that appears in the balance sheet is in commercial values, although it must be confirmed that it still exists at the time of the valuation.
INVESTMENTS: They must be adjusted to the market price at the time of the valuation, taking into account interest valuations, devaluation and the commissions that must be paid to make them effective. In the case of stocks or bonds that are mandatorily convertible into shares, a careful analysis must be made of each and every one of them.
ACCOUNTS RECEIVABLE: The maturities must be analyzed and based on the quality of each one of them, protect them according to the degree of guarantee that is had on them.
INVENTORIES: It must be divided into raw materials, product in process and finished product and set the value for which they could be sold in the market in the state in which they are. The inventory valuation method (FIFO, LIFO, Weighted Average) and the provision for inventories that appear on the balance sheet are irrelevant. Therefore, valuing the inventory can be a very expensive job due to the number of items and the possible exclusivity of them in the market.
FIXED ASSETS AND OTHER ASSETS: For property, plant and equipment, expert appraisers should be consulted who determine their value regardless of whether they are incorporated into a specific business. Difficulties may arise in this area, such as machinery that is not on the market but is vital for the operation of the business.
VALUATIONS AND MEMORANDUM ACCOUNTS: They are not included in determining the commercial value of assets.
Regarding the adjusted liabilities, an analysis of the maturities of each of them must be made to determine the average maturity term that will serve as a qualitative aspect in determining the commercial value of the business. Additionally, those contingent liabilities that are not included in the balance sheet must be calculated and a document legalized with the former owners in which they undertake to take charge of those liabilities generated in previous periods and that are presented after the sale period has concluded..
DETERMINING THE VALUE OF GOOD-WILL
To calculate the value of the intangible Good-Will, a projection of the cash flows must be made without taking into account the financial charges and the amortization of the debt during a fair term; This projection can be defined based on criteria such as technological advances, degree of deterioration of productive assets, the possibility of the appearance of substitute products, etc.
All projections must be made at current prices; that is, taking into account aspects such as inflation, devaluation and increase or decrease in the number of units to produce and sell. The discount rate used will be a market opportunity rate that considers the risk in accordance with the nature of the business and must be agreed between the parties that analyze the transaction. It should be borne in mind that as the discount rate increases, the value of the intangible "Good-Will" decreases, all other conditions being equal.
CASH FLOW SCHEME
Cash Flow Scheme
As can be seen, the cash flow of the business (not of the investor) is similar to the income statement but they differ in that the first is based on CASH and the second based on CAUSATION; The income statement includes interest and cash flow does not, and in cash flow depreciation acts as a tax shield in order to save taxes.
Now, the Good-Will must be calculated based on the cash flow and not based on the income statement, because when acquiring an asset it is expected that it will generate cash benefits that are independent of the degree of indebtedness that said assets have, because the fact of having or not having debts does not affect income and operating costs at all, which are ultimately what determine the Good-Will concept of the business.
PRACTICAL EXERCISE TO CALCULATE THE COMMERCIAL VALUE OF A BUSINESS.
The financial statements and the additional information required to project the financial situation of the LUFY LTDA company for five (5) years are presented.
Calculate commercial value of a business
COMPAÑÍA LUFY LTDA.
INCOME STATEMENT
January 01 to December 31, 19XX
Example Calculation of the Value of a Business
ADDITIONAL INFORMATION
1. Income and costs will increase by 25% annually, for 5 years.
2. 90% of sales are cash and the remaining 10% is recovered in the following year.
3. The total costs and expenses are paid in cash in the same period.
4. Depreciation will be $ 20 per year for each of the 5 years.
5. The Market Opportunity Rate is 32% per year.
Based on the above information, the annual cash flows are projected for 5 years.
COMPAÑÍA LUFY LTDA.
PROJECTED CASH FLOW
Projected Cash Flow
GOOD-WILL
For the Good-Will calculation, the formula of the present value of compound interest is used, like this: VF = VP (1 + i) n from where VP = VF / (1 + i) n
328 + 531 + 662.24 + 826.31 + 1,011.38
--- --- --- ---- --- = $ 1,365.72
(1.32) (1.32) 2 (1.32) 3 (1.32) 4 (1.32) 5
NOTES:
(1) For year one, sales will be: 2,000 x 1.25 * 0.9 + 60 = $ 2,310
For year two, the sales will be: 2,000 x (1.25) 2 x 0.9 + 250 = $ 3,062.50
(2) For year one the variable costs will be: $ 1,100 x 1.25 = $ 1,375
For year one the variable costs will be: $ 1,375 x 1.25 = $ 1,718.75
(3) For year one the fixed costs will be: $ 380 x 1.25 + 20 = $ 495
For year two the fixed costs will be: $ 380 x (1.25) 2 + 20 = $ 613.75
In conclusion, the fair value to be paid by the LUFY LTDA. is $ 3,615.72, represented by $ 2,250 of the net asset value in the market plus $ 1,365.72 of the Good-Will intangible.
It is important to note that the aforementioned figure will only serve as a basis for negotiation, because there are qualitative factors that affect the commercial value of a business, such as: risks of political, economic, and technological changes; alteration in the tastes and preferences of the final consumer of the goods and services produced by the company; concentration of knowledge in the production or marketing of the product in the head of a particular person, the quality of the organization's staff and any other phenomenon that affects the market's perception of the business.
GOOD-WILL ACCOUNTING?
As it is a good that lacks physical substance, it must be recorded as an intangible asset and the counterpart as a surplus of equity, in accordance with Decree 2650/93 Single Plan of Accounts (PUC) for merchants would be:
1605 MERCANTILE
CREDIT 3215 COMMERCIAL CREDIT
16 Intangibles (1 Assets) and 32 Capital Surplus (3 Equity).
For the exercise carried out it would be:
1605 MERCANTILE CREDIT ………………….. $ 1,365.72
3215 COMMERCIAL CREDIT ……………………………………………… $ 1,365.72
STUDY OF THE UNIVERSITY OF ANTIOQUIA
In 1987, the Center for Research and Administrative Consulting of the U of A. collected information in June and July of that year, interviewing financial executives of 138 companies in the city, classified by sectors: Banks, Personal and Social Services, Printing Paper and publishers, Insurance, Commerce and Hotels, Construction, Food, beverages and tobacco, etc.
In the interview, they gave several topics and for each topic several answer options. The conclusions of some topics on average are developed below and in said order of inclination by the financial executives.
THE FINANCIAL GOAL: Maximize Profits; Guarantee the survival of the company; achieve an adequate level of indebtedness and maximize the profitability of the equity.
HIERARCHIZATION OF THE AREAS OF THE COMPANY: Marketing, Quality, Financial, Personnel, Production, Costs-Social Benefit, Systematization and Export
MOST SUITABLE FACTORS TO MEASURE PROPERTY WEALTH: Commercial value of the company; Distribution strength, market size and participation; Growth in the intrinsic value of the share.
CRITERIA FOR VALUING THE COMPANY'S ASSETS: Replacement Prices; Market prices; Adjusted book value.
CRITERIA TO VALUE SHARES: Intrinsic value; financial value and market prices.
FACTORS THAT AFFECT THE VALUE OF SHARES
RELATED TO THE COMPANY
• General control
• Expectations
• Capital
• Management reports
• Economic activity and industrial sector
• Image of the company
• Labor aspects
• Quality of the administration, honesty, image
• History of the company
• Human and technological resources
RELATED TO FINANCIAL MANAGEMENT
• Soundness
• Profitability
• Earnings
• Earnings per share
• Dividend
yield On the value of the investment in assets • Dividend / price ratio
• Liquidity
• Level of indebtedness
• Financial costs • Valuation
outlook
• Value of assets
• Value of the Stock vs. Intrinsic Value •
Dividend Policy
• Company
Value • Commercial Value
RELATED TO THE COMPANY'S MARKET
• Sector to which it belongs
• Product quality
• Distribution force, market size, participation
RELATED TO THE CAPITAL MARKET
• Available information
• Speculation
• Competition from other securities
• Supply and demand
• Investment opportunities
• Concentration of share ownership
• Market transparency
RELATED TO GOVERNMENT POLICIES
• Taxes
• Fiscal Incentives
• Economic Policy
THEORY ABOUT THIS
The market value of the business is determined by factors such as the rate of return on investment, dividend payment, cost of capital, capital structure, etc. And that the range of values of these variables is conditioned by external elements such as the product, the factors of production and the financial markets.
THEORY OF VALUATION OF SECURITIES
The study on the valuation of stock prices is essential to understand the mechanism that allows the transfer of corporate ownership in a market economy. It is also useful for mergers, consolidations and acquisitions.
There are two models: The Quantitative and the Qualitative
QUANTITATIVE MODEL: Part of the premise that the actions of investors and sellers of securities can be explained in terms of certain quantifiable variables and their relationships.
CULITATIVE MODEL: It is based on historical patterns of previous-volume relationships and on the psychology of the market, taking into account the political, economic, national and international circumstances. Sometimes this method serves as the basis for explaining unexpected deviations from the prices calculated in the quantitative model.
METHODOLOGICAL APPROACHES:
There are three methodological approaches:
1. TECHNICAL (Qualitative) The prices of the securities depend on the law of supply and demand, which in turn is subject to other diverse and complex factors from the perspective of analysis. This method is attributed to stockbrokers and is regarded as a short-term trading tool.
For example: The prices of the securities are defined by supply and demand and if they present the following behavior:
Market Value Flow Behavior
2. FUNDAMENTALIST (Quantitative) Prices are determined and can be predicted from the investor's expectations regarding the values that certain variables will present in future periods. It has the following models:
• Dividend
Model • Profit Valuation
Model
• Discounted Cash Flow Model • Investment-Opportunity
Model • Cost of Capital Model
GORDON AND SHAPIRO DIVIDEND MODEL
The present market value of a security is the sum of the security's expected dividend streams.
P = (1 + b) r A / K - rb
A is the total assets of the company
1 - b is the distribution rate
r is the rate that the company anticipates growth
b is the rate that the retention company anticipates stream.
K is the market discount rate
P = D / K - g where D is the dividend per share and G is the growth rate in dividends.
Example: Mr. Lukas is going to determine the share price of LUFY LTDA., Advised by a finance firm he reaches the following conclusions:
Dividends $ 2, Market discount rate 20%, dividend growth 15%:
P = 2 / 0.2 -.15 = $ 40 Mr. Lukas concludes that he can offer $ 40 per share in 100 shares of LUFY LTDA. But the financial statement tells you that the stock is currently at $ 50, so you should review your calculations or abandon the stock for overvaluation.
PROFIT VALUATION MODEL
The market value of a security is determined by the present value of all future earnings.
Pt = Et - It / (1 + K) t
Pt is the market price of the share in period T
Et are the earnings per share in period T
It is the investment per share in period T
K is the rate of market discount
Example: A company expects profits of $ 8 annually, of which it expects to retain $ 5 annually to be reinvested, the subjective discount rate that the investor attributes to the company is 12%
P = 8 -5 / (1 + 0.12) t = 3 / 0.12 = $ 25 "in perpetuity"
Example: Mr. Lukas wishes to invest in LUFY LTDA., If his price range per share is between $ 16 to $ 20. The investment would be for two years. Two years ago the profits of that company were $ 6 and the reinvestment profits $ 4. Last year it was $ 7 and $ 5 was reinvested. Mr. Lukas expects the company to continue with a dividend payment of $ 2 and expects a rate of return on investment of 11%. Therefore, he is willing to buy 100 shares of LUFY LTDA. And you will keep for 2 years as long as you earn a minimum of 11%.
P = E1-I1 + E2-I2 + P2
(1 + k) (1 + k) 2 (1 + k) 2
P = 8-6 / 1.11 + 9-7 / (1.11) 2 + 18 / (1.11) 2 = 1.80+ 1.62 +14.61 = 18.03
The market value of the shares is $ 17.25 and Lukas decides to invest in the $ 100 shares.
DISCOUNTED CASH FLOW MODEL (BODENHORN)
It equates the equity of a company to the present value of all future cash flows between shareholders and the company. These cash flows materialize in the form of dividends, share repurchases or additional sales of shares among shareholders.
The model proposes three variables: initial shareholder investment, expected shareholder wealth at the end of the period, and real shareholder wealth at the end of the period.
W1 = CF1 + P1
W1 Real wealth
CF1 Real cash flow during period 1
P1 Real market price of the stock at the end of period 1
P = CFi / (1 + K) i
P is the initial investment
CFi is the net cash flow anticipated at a term
K is the market discount rate
(W1) = CFi / (1 + k) i-1
(W!) Is the expected wealth
CFi and K indicate values. The first is the expected net flow.
INVESTMENT-OPPORTUNITY APPROACH (SOLOMON) MODEL
The market value of the securities of a company is the sum of the discounted values:
P = V1 + V2 where P is the market value of the company's shares.
• The present value of the constant profits of the assets currently held by the company in perpetuity V1
• The present value of the profits from all future investment opportunities undertaken by the company V2
3. FROM THE RANDOM PATH (Quantitative) Changes in prices cannot be forecast from current or historical information. It starts from two assumptions:
• Successive changes in price are independent and
• They occur according to a certain probability distribution
The first assumption says that the information available in one period cannot be used to predict changes in prices in subsequent periods.
The second assumption indicates that the probability distribution parameters are stationary over time.
CONCLUSIONS
From the point of view of financial economics, the distinction between a small, medium and large company does not lie in its size or number of workers, but in whether or not it belongs to the capital market.
The valuation of a company must be made considering that the life of the company is unlimited, therefore it is essential to add the continuation value to the current value of the estimated income.
It is very likely that the same business has different values for different people, without this implying error on the part of anyone, usually price ranges are obtained, but they should be tried to be narrow.
The factors that are taken into account to determine the Good-Will out of future profits can be all intangible assets such as industrial property, chemical formulas, technical processes, trademarks, patents, literary and artistic property, the generation of profits, optimal position in the market, experience, good location, the quality of the merchandise or service, the treatment of clients, good relations with workers, their job stability, the trust that due to good managerial performance be created in the financial sector.
To have a good approximation of the value, it is necessary to have sufficient and certain information, and a knowledge of the sector or sectors in which it intervenes.
The valuation of a business is made up of two elements: Debt and equity. V = D + C, from where D is the market value of debt and C is the market value of equity.
The mix of knowledge from various professions is affected by subjective aspects such as the interpretation of RISK, therefore, the results may be different for each person, and this does not imply that it is an error.
INTRODUCTION
To value a company it is necessary to combine the knowledge of financial engineering, accounting, business administration, economics, law and other professions.
Economically valuing a company is to project future cash flows to determine the generation of cash and make known to the investor the recovery of its capital.
The valuation of a company that arises on numerous occasions requires the application of valuation methods that normally contemplate the following concepts:
The substantial value of the company
The goodwill (Good-Will)
The substantial value is determined by the difference between the real assets of the company and its payable liabilities, applying market price valuation criteria.
The concept of goodwill arises from the consideration of the company as a “going concern” and therefore from its ability to generate future profits.
Both the figures used to calculate the substantial value and the goodwill require a preliminary study, carried out in accordance with specific criteria, which guarantee the reliability of the information to be used in the specific valuation method that is established..
Good-Will translates “clientele or good name”, clients voluntarily approach this establishment due to the quality of the service provided and its reputation. It is the specific factor of a business that has managed to carve out a name, a position, a clientele and a network of correspondents of all kinds, without such elements being able to materialize. To the Good-Will of the customers is added the favor or trust of the suppliers, employees and all those who maintain relationships with the establishment.
BIBLIOGRAPHY
PHILIPPATOS George C. Fundamentals of Financial Management. Mexico: 1979 McGraw Hill. Page:.357-374
Eaift University Magazine No.70
University of Antioquia Magazine
Internet:
It is the intranet address of the Quick Value company, which uses two methods for business valuation:
•
BLIND SYSTEM • TRADICONAL SYSTEM
The blind system without the need for express mention of the company. In this case, they require:
• Financial statements for the last three years (Balance and Income Statement)
• Budgets and investment plans
• Description of the sector, company and products
• Response Time: 48 hours.
The traditional system is the personalized information of the company.
The purposes of the valuation and the intended use of it are studied here. In this case, the circumstances of each situation will determine the level of information required and the type of report required.
The valuation report will include the definition of the valuation, an economic and financial analysis, an explanation of the most appropriate valuation methods and a reconciliation between the value estimate and its conclusion about the value.
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