case study on business valuation

Corporate Valuation

A Practical Approach with Case Studies

• © 2023
• Benedicto Kulwizira Lukanima 0

Department of Finance and Accounting, Universidad del Norte, Barranquilla, Colombia

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• Provides students with basic knowledge and advance skills for addressing some practical challenges in valuation
• Features case studies, practical, reflective and review questions, and web links
• Features slides, quizzes, Microsoft Excel illustrations, working data and sample syllabi online for download

Part of the book series: Classroom Companion: Business (CCB)

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About this book

This book provides students with basic knowledge and advance skills for addressing practical challenges in valuation. First, the book presents financial information as a vital ingredient for performing corporate valuation. Second, the book presents key concepts of value and valuation and basic techniques for cash flow discounting. Third, the book offers an understanding of the reality of valuation, not simply as a numerical subject, as most people tend to think, but as a combination of objective and subjective aspects. Finally, it examines valuation in relation to the linkage between a firm’s objective, management role in value creation, investors’ decisions, and the valuation role of financial information.

This book is designed and presented to make valuation easily accessible while also not diluting the nature of its complexity. To assist in the learning experience, the author provides illustrative case studies using real world data and review questions tocover all concepts. To assist professors, slides, Microsoft Excel illustrations, working data and sample syllabi are available online for download.

• Corporate finance
• Corporate valuation
• Value maximization
• Cost of capital
• Intrinsic valuation
• Equity valuation
• Firm valuation
• Investment decision
• Financial statement analysis
• Intrinsic value
• Relative value
• market value
• valuation challenges
• valuation techniques
• value creation
• free cash flow

Table of contents (22 chapters)

Front matter, the concept of value, existence of a firm, and the objective value maximization, an overview of corporate valuation.

Benedicto Kulwizira Lukanima

Corporate Value Creation

Time value of money, security markets and valuation, financial information as a source of valuation inputs, an overview of financial information, the basics of financial statement analysis, profitability analysis, financial leverage analysis, market perception analysis, free cash flows, the cost of capital, an overview of capital structure and cost of capital, the cost of equity, the cost of debt, intrinsic valuation, estimating growth rates, free cash flow discount models: cost of capital approach, authors and affiliations, about the author.

Benedicto Kulwizira Lukanima is Assistant Professor in the Department of Finance and Accounting at Universidad del Norte (Barranquilla, Colombia).

Bibliographic Information

Book Title : Corporate Valuation

Book Subtitle : A Practical Approach with Case Studies

Authors : Benedicto Kulwizira Lukanima

Series Title : Classroom Companion: Business

DOI : https://doi.org/10.1007/978-3-031-28267-6

Publisher : Springer Cham

eBook Packages : Economics and Finance , Economics and Finance (R0)

Copyright Information : The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023

Hardcover ISBN : 978-3-031-28266-9 Published: 05 August 2023

Softcover ISBN : 978-3-031-28269-0 Published: 05 August 2024

eBook ISBN : 978-3-031-28267-6 Published: 04 August 2023

Series ISSN : 2662-2866

Series E-ISSN : 2662-2874

Edition Number : 1

Number of Pages : XXVI, 705

Number of Illustrations : 14 b/w illustrations, 166 illustrations in colour

Topics : Business Finance , Financial Accounting , Financial Services , Macroeconomics/Monetary Economics//Financial Economics

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Modern methods of business valuation—case study and new concepts.

1. Introduction

2. methodology, 3. literature review, the process of business valuation–the essence and classification of methods.

• is an invariably important issue of the economic essence of ownership, which is closely linked to issues of usability and the problem of the monetary value of an object of property,
• is the market measure of the effectiveness and efficiency of actions taken by the enterprise.
• Valuation objective;
• Who orders (recipient);
• Type of the company due to usability;
• Economic condition of the company and the condition of the environment (economy, industry, region);
• Type, scale and diversity of business;
• Type and number of assets;
• Operation and development prospects of the company;
• Type and quality of information about the company and the market that it is possible to obtain;
• Approaches and types of value in business valuation.
• Compliance of the valuation with the facts;
• Timeliness of data, transparency and relative simplicity;
• Clearly defined purpose of its preparation;
• Being based on the financial data of the company;
• Not being made exclusively on the basis of the value of the company’s assets unless it concerns the so-called liquidation method;
• Taking into account income and intangible factors;
• Taking into account the company’s development forecasts and risk factors;
• Taking into account all relevant information which affects the valuation and is available in the process of its preparation;
• Being objective and reliable.
• Freedom of selection of input data,
• Use of wide subjectivity in the common valuation procedure,
• Subjectivity of selection of valuation methods and internal parameters,
• Lack of coherence in estimation of parameters,
• Lack of legal regulations and standards of valuation.

4.1. The Examples of Business Valuation Using the Adjusted Net Assets Method–Case Study

4.1.1. the practice example no. 1—valuations using the adjusted net assets method, 4.1.2. the practice example no. 2, 4.1.3. the practice example no. 3.

• The office building worth (according to the appraisal report of 2009) PLN 3 million,
• The production building worth (according to the appraisal report of 2009) PLN 5 million,
• The assembly line of 2003 worth (in the valuator’s opinion) PLN 0.5 million,
• Stocks of materials and products worth PLN 4 million,
• Receivables worth PLN 3 million, PLN 0.5 million of which is uncollectible.
• Objectivity and ease in carrying out by oneself,
• Access only to basic data,
• Taking into account the condition and usability of assets for operation,
• Possibility to compare with the value determined using other methods,
• Possibility to determine the lower range of values in negotiations.
• On the other hand, the primary disadvantages include:
• Not taking into account important components of the company’s value not recorded in the balance sheet, e.g., contracts of the company, knowledge of employees, possessed brands and value of trademarks;
• Possibility to determine only the value of assets in the categories of the so-called material substance, which usually underestimates the value of the operating enterprise.

4.1.4. The Practice Example No. 4

4.2. the analysis of methods and the valuation process to establish the determinants of value subjectivity.

• WP—business value (net book value),
• A—total balance sheet value of assets,
• P o —balance sheet value of foreign liabilities,
• KW—balance sheet value of equity.
• AW—total adjusted assets value,
• POW—value of adjusted foreign liabilities,
• KWW—value of adjusted equity.
• W ON —net replacement value (the value of the fixed asset, taking into account its physical and moral wear),
• W OB —gross replacement value (the value of the new fixed asset),
• Z f —physical (technical) wear indicator, 0   ≤   Z f ,
• Z m —moral wear indicator (technological change, aging), Z m   ≤ 1 .
• t—year of the analysis,
• a t —discount rate for the year t,
• D t —income in the year t.
• W d —income value,
• NCFt—net cash flows for the year t,
• RV—residual value.

4.3. The Methodology of Business Valuation According to the MDI-R Concept

• M—the company’s assets,
• Po—foreign liabilities,
• W st —value of the fixed asset,
• W n —value of a new fixed asset,
• Z f —wear rate of the fixed physical asset, in the range of 0 <= Z f <= 1,
• NOPAT —projected annual net operating profit after tax,
• WACC —discount rate, reflecting weighted average cost of capital of the valuated company.
• W NiP —market value of single, specific intangible and legal assets,
• w 1 , w 2 —known market prices of similar intangible and legal assets,
• n —number of transactions of the specific value.

5. Discussion and Conclusions

Author contributions, acknowledgments, conflicts of interest.

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Miciuła, I.; Kadłubek, M.; Stępień, P. Modern Methods of Business Valuation—Case Study and New Concepts. Sustainability 2020 , 12 , 2699. https://doi.org/10.3390/su12072699

Miciuła I, Kadłubek M, Stępień P. Modern Methods of Business Valuation—Case Study and New Concepts. Sustainability . 2020; 12(7):2699. https://doi.org/10.3390/su12072699

Miciuła, Ireneusz, Marta Kadłubek, and Paweł Stępień. 2020. "Modern Methods of Business Valuation—Case Study and New Concepts" Sustainability 12, no. 7: 2699. https://doi.org/10.3390/su12072699

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Valuing Peloton

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About The Author

E. Scott Mayfield

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The Amazon Case Study (New Edition)

• What You'll Learn
• Career Programs
• What Students Say

The Amazon Case Study

Welcome to CFI’s advanced financial modeling course – a case study on how to value Amazon.com, Inc (AMZN).  This course is designed for professionals working in investment banking, corporate development, private equity, and other areas of corporate finance that deal with valuing companies and applying various methods of valuation.

Advanced Financial Modeling Course Objectives

This advanced financial modeling course has several objectives including:

• Use Amazon’s financial statements to build an integrated 3-statement financial forecast
• Learn how to structure an advanced valuation model effectively
• Set up all the assumptions and drivers required to build out the financial forecast and DCF model
• Create a 10-year forecast for Amazon’s business, including an income statement, balance sheet, cash flow statement, supporting schedules, and free cash flow to the firm (FCFF)
• Learn how to deal with advanced topics like segmented revenue, capital additions, finance leases, operating leases, and more
• Perform comparable company analysis (Comps) utilizing publicly available information
• Perform a Sum-Of-The-Parts (SOTP) valuation of Amazon, as well as consider precedent transactions, equity research price targets, and Amazon’s 52-week trading range
• Generate multiple operating scenarios to explore a range of outcomes and values for the business
• Perform detailed sensitivity analysis on key assumptions and assess the overall impact on equity value per share

Amazon (AMZN) Case Study

This course is built on a case study of Amazon, where students are tasked with building a financial modeling and performing comparable company analysis to value AMZN shares and make an investment recommendation.

Through the course of the transaction, students will learn:

• How to build a detailed financial forecast of Amazon
• How to apply various valuation methodologies to derive an implied value for Amazon
• How to develop an investment recommendation on the shares of Amazon
• How to create a dashboard and summary output that highlights the most important information from the model

Why Take CFI’s Advanced Financial Modeling Course?

This course is perfect for anyone who wants to learn how to build a detailed financial model for a public company, from the bottom up. The video-based lessons will teach you all the formulas and functions to calculate things like segmented revenue, marketable securities, accrued expenses, unearned revenue, stock-based compensation, long-term debt, finance and operating leases, and much more.

In addition to learning the detailed mechanics of how to build the financial model for Amazon, students will also learn how to think about intrinsic value, and develop an investment recommendation.

What’s Included in the Advanced Modeling Course?

This advanced financial modeling and valuation course include all of the following:

• Blank Amazon model template
• Completed Amazon model template (dashboard, DCF model, Comps model, WACC analysis, scenarios, etc.)
• 4+ hours of detailed video instruction
• Certificate of completion

Recommended Preparatory Courses

We recommend you complete the following courses or possess the equivalent knowledge before taking this course:

• Excel Fundamentals – Formulas for Finance
• DCF Valuation Modeling
• Comparable Valuation Analysis
• 3-Statement Modeling

This course is intended solely for educational and training purposes. The information contained herein does not constitute investment advice, or an offer to sell, or the solicitation of any offer to buy any securities of Amazon.com, Inc. (NasdaqGS: AMZN) or any other security.

This content in this course has not been approved or disapproved by (a) Amazon.com, Inc., (b) S&P Global Market Intelligence Inc., (c) any equity research analyst that covers Amazon.com, Inc., or (d) any securities regulator in any province or territory of Canada, the United States Securities and Exchange Commission or any other United States federal or state regulatory authority, and no such commission or authority has passed upon the merits, accuracy or adequacy of this content, nor is it intended that any will.

The information in this course does not constitute the provision of investment, tax, legal or other professional advice. As with all investments, there are associated risks and you could lose money investing – including, potentially, your entire investment. Prior to making any investment, a prospective investor should consult with its own investment, accounting, legal and tax advisers to evaluate independently the risks, consequences and suitability of that investment.

No reliance may be placed for any purpose on the information and opinions contained herein or their accuracy or completeness, and nothing contained herein may be relied upon in making any investment decision.

Approx 12.5h to complete

100% online and self-paced

What you'll learn

Introduction, building a financial forecast, implied value analysis, investment recommendation, course conclusion, qualified assessment, this course is part of the following programs.

Why stop here? Expand your skills and show your expertise with the professional certifications, specializations, and CPE credits you’re already on your way to earning.

Financial Modeling & Valuation Analyst (FMVA®) Certification

• Skills Learned Financial modeling and valuation, sensitivity analysis, strategy
• Career Prep Investment banking and equity research, FP&A, corporate development

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Case Study: Adding Value Through Business Valuation

• BizEquity Team
• January 17, 2024

See how Boston Integrity is able to charge an extra $2,500 per engagement

As a solo practitioner and fee-based Financial Planner, Randall Boston ChFC® of Boston Integrity specializes in comprehensive financial planning services for business owners. 

In this case study, we outline how, with the help of the BizEquity Platform, he was able build upon his existing planning services by offering on-demand business valuations thereby seeing:

• An Extra $2,500 Valuation Fee Per Engagement
• Improved Client Retention 
• A Higher Close Ratio, Particularly for Larger Clients

For more information on the partnership between ThinkAdvisor and BizEquity, visit bizequity.com/alm-thinkadvisor . 

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Comparing Business Valuation Methods: Which One is Right For You?

• Posted on April 17, 2024

Table of Contents

When embarking on the journey of buying or selling a small business, one crucial step that cannot be overlooked is business valuation. Understanding the worth of a business is foundational to negotiating a fair and beneficial deal for all parties involved. Yet, with various business valuation methods available, choosing the one that best suits your specific needs and transaction characteristics can feel like navigating a maze without a map.

At its core, business valuation is more than just numbers and calculations; it’s about comprehensively understanding what a business is worth in the market and to potential buyers or sellers. This process is vital in the lower middle market, where transactions range from $1M to $100M in enterprise value. Here, the stakes are high, and the right valuation can make or break a deal.

This article delves into the most common business valuation methods, offering a comparative analysis to shed light on their applicability in various scenarios. Whether you’re a seasoned M&A professional, a small business owner, or somewhere in between, understanding these methods is key to selecting the right one for your transaction. We’ll cover:

• An Overview of Business Valuation Methods , touching on the main categories and their significance.
• Asset-Based Approaches , Earning Value Approaches , and Market Value Approaches , detailing the pros and cons of each and discussing ideal scenarios for their use.
• Tips for Selecting the Right Valuation Method , helping you navigate this critical choice with confidence.

With the right knowledge and insights, selecting the appropriate valuation method can transform from a daunting task into a strategic decision that propels your M&A transaction toward success. Let’s embark on this detailed exploration together, armed with the keywords: business valuation, comparing business valuation methods, valuation method overview, and choosing valuation methods, to guide us through.

Overview of Business Valuation Methods

Understanding the value of a business is paramount in the complex landscape of mergers and acquisitions, especially for transactions within the lower middle market. The valuation process provides a solid foundation, guiding negotiation strategies and informing both parties about what constitutes a fair and equitable deal. Given the diverse nature of businesses and the myriad of factors influencing their value, there is no one-size-fits-all approach to business valuation. Instead, professionals rely on a variety of methods, each suited to different types of businesses and transaction scenarios.

Broadly speaking, business valuation methods fall into three main categories:

• Asset-Based Approaches : These methods calculate a business’s value based on the net asset value of its tangible and intangible assets. This approach is straightforward and tangible, making it particularly suitable for businesses rich in physical assets.
• Earning Value Approaches : Centering on a business’s ability to generate wealth in the future, these methods are predicated on the notion that a business’s true value lies in its potential for future earnings. This approach is favored for businesses with stable and predictable cash flows.
• Market Value Approaches : These methods determine a business’s value based on the selling price of comparable businesses in the market. This approach is highly practical, reflecting current market trends and the real-world transaction values of similar businesses.

Each of these methods brings a unique perspective to the valuation process, offering insights based on different aspects of a business’s operations, assets, and market position. The choice among these methods depends on a variety of factors, including the nature of the business being valued, the reason for the valuation, and the availability of data.

Understanding these methods is crucial for anyone involved in the M&A process, from small business owners looking to sell to boutique private equity firms making strategic acquisitions. With the right approach, stakeholders can ensure that they are making informed decisions based on a comprehensive understanding of a business’s worth.

In the following sections, we will delve deeper into each of these methods, exploring their advantages, disadvantages, and the scenarios in which they are most applicable. This exploration aims to equip you with the knowledge needed to navigate the complexities of business valuation, making the process transparent and approachable.

Asset-Based Approaches

In the realm of business valuation, asset-based approaches stand out for their straightforward methodology and focus on tangible assets. This method is grounded in the principle that a business’s value can be determined by assessing the net asset value of its tangible and intangible assets. It’s a method that strips down a business to its core components, offering a clear, albeit sometimes simplistic, picture of its worth.

Description

Asset-based valuation methods operate by calculating the total value of a company’s assets and subtracting the value of its liabilities. This approach can be applied in two ways:

• Going Concern Asset-Based Approach : Assumes the business will continue operating and values the assets in the context of their contribution to the company’s ability to generate income.
• Liquidation Asset-Based Approach : Assumes the business will cease operations and assets will be sold off, with the valuation based on the expected proceeds from such a sale.

Pros and Cons

• Simplicity : Asset-based approaches are relatively straightforward to understand and apply, especially when accurate records of assets and liabilities are available.
• Tangibility : This method provides a tangible floor value for a business, based on physical and measurable assets.
• Limited Future Earnings Consideration : It often fails to account adequately for the future earning potential of the business, which can be a significant component of its value.
• Intangible Assets : The method may undervalue or overlook intangible assets like brand reputation or intellectual property, which can be pivotal in certain industries.

Applicability

The asset-based approach is particularly suited for businesses with significant tangible assets, such as real estate or manufacturing companies. It’s also applicable in scenarios where a business is being liquidated or when it’s necessary to establish a baseline value for a business that may be underperforming or has a complex structure.

For businesses in the lower middle market, especially those pursuing transactions between $1M and $100M in enterprise value, this method provides a clear starting point. It’s often used in conjunction with other valuation methods to ensure a comprehensive assessment of a business’s value.

In the context of small business acquisitions, the asset-based approach serves as a crucial tool for determining a minimum value but should be balanced with other methods to capture the full spectrum of the business’s worth. This approach underscores the tangible assets a business holds but must be tempered with an understanding that the true value of a business often lies beyond its physical assets.

Earning Value Approaches

The earning value approaches to business valuation center on a fundamental principle: a business’s true worth is reflected in its ability to generate income in the future. Unlike the asset-based methods, which focus on tangible and intangible assets, earning value approaches look forward, projecting the future cash flows or earnings of a business. This perspective is particularly valuable for evaluating businesses where the primary assets are their operations and profitability rather than physical assets.

Earning value approaches are primarily divided into two methodologies:

• Capitalizing Past Earnings : This method determines a business’s expected level of future profitability based on its historical earnings, factoring in the business’s stability, growth, and profitability.
• Discounted Cash Flow (DCF) : Arguably the most forward-looking valuation method, DCF forecasts the business’s future cash flows and discounts them back to their present value using an appropriate discount rate, which reflects the risk and time value of money.
• Future-Oriented : These methods emphasize the future earning potential, aligning closely with investment principles.
• Flexibility : They allow for adjustments based on future economic and business forecasts, making them adaptable to various scenarios.
• Complexity : Calculating future earnings and selecting the correct discount rate can be complex and requires a thorough understanding of finance.
• Assumptions and Predictions : The accuracy of these methods depends heavily on the assumptions and predictions made, which can introduce uncertainty.

Earning value approaches are most applicable to businesses with a track record of stable and predictable earnings. They are particularly suited for service or technology companies, where the primary value lies in operational profitability and future growth potential, rather than in tangible assets.

These methods are vital for assessing businesses in the lower middle market, especially those involved in transactions between $1M and $100M in enterprise value. In these cases, understanding the nuances of a business’s earning potential can significantly impact the valuation and, consequently, the negotiation and transaction process.

For DueDilio clients, such as searchers, independent sponsors, and small family offices, the earning value approaches provide a nuanced and dynamic tool for evaluating investment opportunities. They offer a way to capture the essence of a business’s value beyond its physical assets, highlighting its future potential and growth trajectory.

In conclusion, while earning value approaches offer a sophisticated and insightful lens through which to view a business’s value, they require a careful consideration of future uncertainties and the assumptions underlying the forecasts. When applied with diligence and expertise, these methods can unveil the intrinsic value of businesses whose assets are not as tangible but whose future earnings prospects are promising.

Market Value Approaches

Moving from the tangible assets and potential future earnings of a business, we delve into the market value approaches. These methods offer a perspective based on the broader market context, assessing a company’s worth in comparison to similar businesses that have been sold or are currently on the market. It’s a method that mirrors the principle of “comparables,” common in real estate valuation, applied to the business world.

Market value approaches determine a business’s value by looking at the sale prices of similar businesses in the same industry or geographic location. The premise is straightforward: the value of your business can be estimated based on what buyers are willing to pay for similar businesses. This method often involves metrics such as price-to-earnings (P/E) ratios, sales, and other relevant financial ratios.

• Market Relevance : Provides a valuation grounded in the reality of the current market, reflecting what investors are actually paying for businesses.
• Comparative Analysis : Offers insights into how similar businesses are valued, facilitating a competitive understanding of market positioning.
• Availability of Comparables : In some industries or niche markets, finding sufficiently similar businesses for a meaningful comparison can be challenging.
• Differences in Operations and Strategy : Even within the same industry, significant variations in business models and strategies can lead to discrepancies in value that are not accounted for by this method.

Market value approaches are particularly effective in industries with frequent transactions and a high degree of comparability between businesses, such as retail, restaurants, or small service-based businesses. They’re best suited for situations where there is ample data on recent sales or listings of comparable businesses, allowing for an accurate market-based assessment.

For small businesses in the lower middle market, this approach can offer a reality check against other valuation methods, providing a lens through which to view how the market at large would value the business. It’s especially useful for owners considering a sale and wanting to understand their business’s market positioning or for buyers looking to ensure they pay a fair price.

Utilizing market value approaches requires a careful consideration of the comparability between the subject business and its peers, as well as an understanding of current market dynamics. While this method offers a grounded perspective, it should be part of a broader valuation strategy that considers the unique aspects of the business being valued.

Detailed Comparison of Methods

Having explored the asset-based, earning value, and market value approaches, it’s crucial to understand how these methods compare and when each is most appropriate. This comparison can help guide business owners, M&A professionals, and advisors in choosing the right valuation method for specific transaction scenarios in the lower middle market.

Direct Comparison

• Asset-Based Approaches focus on tangible and intangible assets, ideal for asset-rich companies.
• Earning Value Approaches estimate future earning potential, suited for businesses with stable and predictable cash flows.
• Market Value Approaches derive value from comparable market transactions, best for industries with frequent sales of similar businesses.
• Asset-Based methods can be straightforward but may undervalue businesses without significant tangible assets.
• Earning Value methods, especially those involving future earnings like DCF, require more assumptions and projections, increasing complexity.
• Market Value approaches depend heavily on the availability of data on comparable transactions, which may not be accessible for all industries.
• Asset-Based approaches are suitable for valuation floors or for businesses in liquidation.
• Earning Value methods are preferred for valuing ongoing businesses with clear financial projections.
• Market Value approaches are applicable when ample comparable sales data is available, providing a market-grounded valuation.
• Case Studies

To illustrate these differences, let’s consider hypothetical scenarios:

• A Manufacturing Company : With significant equipment and property, an asset-based approach might provide a solid valuation floor, but an earning value approach could better capture the company’s profitability and market position.
• A Tech Startup : With minimal tangible assets but significant growth potential, earning value methods like DCF would likely offer a more accurate valuation, reflecting the startup’s future earnings prospects.
• A Retail Chain : For a business in a sector with many comparable transactions, the market value approach would allow for a valuation grounded in current market realities, offering insights into how similar businesses are valued.

Choosing the right valuation method involves considering the specific characteristics of the business, including its industry, market position, asset base, and future earning potential. Often, a combination of methods provides the most comprehensive view, leveraging the strengths of each to arrive at a nuanced valuation.

Selecting the Right Valuation Method

Navigating the complexities of business valuation requires not just an understanding of the different methods available but also an insight into how to choose the right one for a specific business and transaction scenario. This selection is crucial, especially in the lower middle market, where the diversity of businesses and transaction sizes can significantly impact the valuation process. Here are some key factors to consider and tips for making this critical decision.

Factors to Consider

• Nature of the Business : Consider whether the business is asset-heavy, service-oriented, or technology-focused. Each type of business may lean towards a different valuation method.
• Stage of the Business : Assess whether the business is a startup, in a growth phase, mature, or in decline. This stage can influence the predictability of future earnings and the relevance of current assets.
• Market Conditions : Evaluate the current market conditions and transaction activity within the industry. A higher frequency of comparable sales can make market value approaches more viable.
• Purpose of the Valuation : The reason behind the valuation—whether for a sale, fundraising, or internal assessment—can dictate the most appropriate method to use.

Tips for Selection

• Combine Methods When Necessary : Often, using a combination of methods provides a more comprehensive and accurate valuation. For instance, starting with an asset-based approach to establish a floor value and then applying an earning value method can capture both tangible and future value.
• Consult with M&A Professionals : Engaging with M&A advisors and valuation experts, especially those with experience in your specific market segment, can provide invaluable insights into the most suitable valuation methods.
• Keep an Eye on Industry Trends : Industry trends and recent transactions can offer clues about which valuation methods are currently favored in the market and may be more persuasive to potential buyers or investors.
• Be Prepared to Defend Your Valuation : Regardless of the method chosen, be prepared to explain and defend your valuation to potential buyers, investors, or other stakeholders. A well-documented and reasoned valuation can facilitate smoother negotiations and transactions.

Choosing the right business valuation method is a critical step in the M&A process, one that can significantly impact the success of a transaction. By understanding the pros and cons of each approach and considering the specific characteristics and circumstances of your business, you can make an informed decision that reflects the true value of your company. Remember, the goal is not just to arrive at a number but to understand and articulate the value of the business in a way that is compelling and defensible.

For those navigating the complexities of small business M&A, DueDilio stands as a trusted partner, offering access to a vast network of highly vetted independent professionals and boutique firms specializing in M&A advisory, due diligence, and valuation. Whether you’re a searcher, a small family office, or an SMB, DueDilio can help you assemble the right deal team to ensure that your transaction is built on a foundation of accurate and strategic valuation.

Frequently Asked Questions

Choosing the right valuation method is critical because it ensures that the assessed value of a business accurately reflects its true worth. An appropriate method takes into account the unique aspects of the business, such as its industry, asset base, earnings potential, and market conditions, leading to a fair and reliable valuation. This is especially important in negotiations for sales, acquisitions, or mergers.

The best-suited valuation method for your business depends on several factors, including the nature of your business (service, manufacturing, tech, etc.), the stability of your earnings, the presence of tangible vs. intangible assets, and market comparables. Consulting with an M&A advisory firm like DueDilio can help you determine the most appropriate method based on these factors.

A business should be revalued whenever there’s a significant change in its operations, market conditions, or when considering a sale, acquisition, or merger. Additionally, regular valuations, such as annually or bi-annually, can help business owners understand how their company’s value is evolving over time.

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Written by Roman Beylin

Roman Beylin is the founder of DueDilio, a leading online marketplace to assemble an M&A deal team. Our large and growing network of highly vetted independent professionals and boutique firms specialize in M&A advisory, due diligence, and post-acquisition value creation.

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Business Valuation Case Study: Cash Flow is King

Case Background

The business in question was a sole proprietorship that provided “sales, repair, and installation” services to homes and businesses. The business operated out of a 2,500 square foot shop located at the owner’s residence. The business did not pay rent for use of the facilities, did not pay a salary to the owner for his services, but did pay a small wage to the spouse. The business had a consistent revenue stream, but profitability varied year to year.

Approaches Used

The opposing valuation expert (Expert A) relied solely on the Privately Traded Guideline Company Method to determine the value of the business . Expert A used the Pratt’s Stat’s – Private Company Merger and Acquisition database to search for transactions involving companies deemed similar to the subject business. Using search criteria of similar NAICS codes, a comparable range of revenue, and a timeframe of the previous 10 years to the effective date of the valuation, Expert A found 38 transactions involving companies deemed comparable to the subject business. Using these 38 transactions, Expert A determined that the mean (average) sales multiple was 0.73. Expert A then multiplied this sales multiple by an average of the previous 3 years sales to arrive at the estimated enterprise value of the business of approximately $432,000.

I also used the Privately Traded Guideline Company Method in my valuation, and the same historical data as Expert A, but made normalization adjustments to the income statements to account for the market rate rent expense for the shop, estimated market level compensation of the owner based upon services performed, and removed compensation paid to the spouse which would not be required for operation of the business. I also used the Pratt’s Stat’s database and similar search criteria. My search resulted in 40 transactions which included all 38 transactions that Expert A used. In addition, I chose the Seller’s Discretionary Earnings (SDE) multiple and the sales multiple as the two multiples to use in my valuation. According to Pratt’s Stats FAQ, it defines SDE as Operating Profit (Earnings Before Interest and Taxes) + Owners Compensation + Depreciation/Amortization. I believe that SDE closely resembles the earnings stream available to a purchaser of the business and thus is the more relevant multiple.

By way of example, my report stated,

“If you have two similar companies that both generate $500,000 in net sales annually, but Company A produces cash flow available for distribution to an owner of $150,000 while Company B produces $25,000, Company A will be more valuable than Company B regardless of the top line revenue. Using a net sales multiple alone does not account for the differences in profitability of the companies in the sample, unless the revenue multiple selected represents comparable profitability to the subject company.”

I calculated the normalized SDE for the subject company (considering the normalization adjustments discussed previously) and then calculated the SDE as a % of sales for the subject company. This percentage was then compared to the SDE as a % of sales for the transactions in my search. The results were the subject company’s normalized SDE as a percentage of sales approximated the SDE as a % of sales in the 21st percentile of the transactions in my search. The SDE multiple for the 21 st percentile associated with the transactions was 1.93 times SDE. I also calculated the sales multiple for the 21 st percentile which was 0.41 times revenue. By using these two multiples to calculate the estimated enterprise value of the business, the end result was approximately $145,000.

My approach considered the bottom line cash flow available to a potential purchaser of the business and used multiples corresponding to transactions with similar levels of cash flow. My report highlighted that top line measures of profitability, such as revenue, should be supported with an analysis to show its relationship with bottom line cash flow measures. Simply put, if the “mean” multiple for revenue should be used, then the bottom line cash flow available to a purchaser of the business should approximate the “mean” cash flow of the data set. Within these transactions it did not, and I believed a different multiple should be used.

The judge on the case heard arguments from both sides and due to the disparity in results called for a 3 rd independent valuation expert to review both reports and state to the court which approach they believed was more credible. The 3 rd expert testified that they would have valued the company using a bottom line cash flow approach that considered normalization adjustments similar to ones used in my report. When asked if they would have used the “mean” revenue multiple, they stated that they would only have used it if the bottom line cash flow approximated the “mean” of the data set for the transactions considered. The judge ruled in favor of my valuation report.

Visit our webpage for more information on McKonly & Asbury’s Business Valuation Services . Should you have questions about the importance of the cash flow available to a purchaser of a business, or business valuation in general, don’t hesitate to contact me, T. Eric Blocher CPA, ASA, CVA at [email protected] .

About the Author

McKonly & Asbury is a Certified Public Accounting Firm serving companies across Pennsylvania including Camp Hill, Lancaster, Bloomsburg, and Philadelphia. We serve the needs of affordable housing, construction, family-owned businesses, healthcare, manufacturing and distribution, and nonprofit industries. We also assist service organizations with the full suite of SOC services (including SOC 2 reports), ERTC claims, internal audits, SOX compliance, and employee benefit plan audits.

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Modern Methods of Business Valuation—Case Study and New Concepts

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1. Introduction The term “enterprise” or “company” can be understood as a separate economic entity, an economic entity producing and selling on its own account goods and services with the goal to maximize profits. Modern enterprise financial management is about maximizing its value. An enterprise is a special form of investment. The owners, by investing in their own capital resources, expect to obtain certain benefits resulting from the multiplication of capital invested in this way, which leads directly to the increase in the value of the enterprise they own. Recognizing at the same time that the economic essence of ownership issues is closely related to issues of utility and the problem of the monetary value of the object of ownership, the issues relating to enterprise value, its specifics, various conditions, as well as methods and training procedures, are invariably important.

Business valuation is a complex process that requires the application of the vast knowledge of many fields of science, and there are many scientific and practical problems associated with this [1]. Despite the fact that a group of specialists has already done much in terms of efforts to standardize the valuation process, there are still many unsolved problems or controversial solutions adopted. Methods of the valuation of enterprises and their organized parts have not been regulated legally as strictly binding [2]. Also, there is no closed and complementary set of rules applicable to this process. The lack of uniform regulations is primarily due to the fact that it is not possible to fully codify a process that may relate to entities with different specificities, legal forms, assets or ownership structures. However, there are standards that allow for its partial structuring. Therefore, in many countries of the world, for many years, there have been standards for business valuation [3]. They relate to the methodology of valuation and the range of expertise that the valuator must have. They were developed by professional organizations that contain specialists in dealing with valuations. Experts are bound by codified procedures and standards of conduct, which guarantee the comparability of valuations and ease of their verification. Such a situation contributes to the security of business transactions.

The need for business valuation results from economic development. Along with the globalization of the economy, which is accompanied by an intense flow of capital to a growing number of countries, valuation becomes necessary to the sale, privatization, mergers and acquisitions or creation of joint ventures and many other processes relating to enterprises [4]. Determination of the final value of the entity is difficult due to the subjectivity of the concept of “value” itself. The problem is also the fact that business valuation is the combination of both theory and practice. It also depends on the capabilities of the business model used by the specific economic entity. It should be remembered, though, that the actual market value of the enterprise is very rarely exclusively determined by the assets taken into account in the balance sheet. The actual valuation is determined by a number of variable factors, such as the economic situation of the country, attractiveness of the market, the company’s development strategy, human resources, the nature and manner of the use of assets owned [5]. Therefore, it can be stated that business valuation is the process of estimation of the price for assets and benefits achieved by the company as a result of their effective management. It is carried out in the moment, since the market is like a living organism and new information affecting the condition and operations of enterprises occurs over and over again.

Therefore, because of the complicated, constantly changing processes of business valuation, it is important to establish certain norms and legal standards. The International Valuation Standards Council developed a document including international norms in this field [6]. It contains the guidelines recommended in the process of assessment of the company’s value, as well as appraisal reports and recommendations concerning their application. Obviously, these rules are not strictly binding, however, they constitute a set of good practices and guidelines specifying certain generally accepted principles, both ethical and methodological. This aims at the elimination of significant disparities in relation to the results of the valuation made, e.g., with respect to the assets of the same type. These rules may be also applicable in the case of court disputes concerning the outcome of the valuation, as well as doubts about the valuation for tax purposes. In the countries where a certain framework and standards for estimating the value of assets have been determined, there is separate certification of experts in the field of valuation.

The objective of the article is to demonstrate the need to improve the code of conduct and valuation standards. Within the framework of the accomplishment of the objective, the multidimensionality as well as the complex issues of valuation are presented along with the factors that could distort the establishment of fair value. 2. Methodology The research methodology was based on a review of scientific literature and conclusions drawn from business valuation methodology. As part of this methodology a detailed analysis was performed of the subsequent stages of business valuation methods used in business practice. Also in the article practical examples were verified. On their basis, the hypothesis about the existence of key valuation elements was verified, which allows the use of broad subjectivity when estimating the value of assets. The research methodology used demonstrated the need to improve the code of conduct and valuation standards. Additionally, as part of the critical analysis, factors that may distort the determination of fair value were presented. Therefore, the original concept of MDI-R was presented to improve practical valuation methods. At the same time, the necessity of further development of valuation methods and the search for objective methods of fair value measurement for the conducted business was shown, which require further detailed research based on the analysis of numerical data on practical examples. 3. Literature Review

Business valuation is a set of procedures, analyses and assessments leading to the estimation of the company’s value in monetary units for the specific moment [7]. Contemporary realities of the market economy and the globalization process have determined that business valuation is of fundamental importance for economic processes. Contemporary management of corporate finance consists in maximizing its value. Business valuation is the process of estimating the price of assets (fixed and current assets, as well as different intangible assets and characteristics) and benefits achieved due to their effective management [8]. Generally, the objective of business valuation is always to facilitate strategic decision-making in terms of organization, shares or investments. Valuation enables the selection of both ownership and financial options in assets and liabilities. It is actually the opinion of the value prepared by specialized experts, analysts and valuators on the basis of the collected and properly utilized information about the company considered and the environment of its operations [9]. At the same time, it can be acknowledged that the company’s value is the market measure of the effectiveness and efficiency of actions taken by the enterprise. Despite such a crucial function performed by business valuation in the economy, its specificity and essence pose many problems. These are related to a variety of conditions and numerous procedures and methods serving business valuation. Another component resulting in problems in the valuation of fair value is the growing importance of intellectual capital. This is due to global technological and organizational transformations, which have led to the knowledge-based economy. Intellectual capital, among others, consists of legal assets, technology and relationships with customers. At the same time, among the issues of intellectual capital, there are many ambiguous and various solutions for both theory and practice. Due to difficulties in the valuation of intangible and legal assets, which primarily determine the contemporary value of enterprises, in particular highly developed ones, in terms of technology, one deals with difficulties in achieving the so-called fair business valuation [10]. The methodology of the valuation of intangible and legal assets is subject to constant changes in search of a universal method. Therefore, at present, in the subject literature, the conclusion is that, in order to make the best possible valuation, it is necessary to valuate individual components affecting the value of the company with separate methods that best reflect the nature of their value.

The existence of many subjective factors affecting the valuation may lead to abuse, pressure and the desire to influence the experts’ decisions, which result in the distortion of fair value. Therefore, in order to streamline business valuation, there is the need to develop a synthetic and universal, yet consistent, methodology for the valuation of basic parameters. This also requires the implementation of appropriate regulations or standards concerning the generally accepted methods of business valuation since, depending on the subjective choice of the method by the appraiser, significant differences in the final valuation may be observed, resulting in low values of the company [11]. Therefore, the objective should be to develop standards that will determine acceptable methods (patterns) for specific industries or cases. All practitioners carrying out business valuations must accept certain fundamental principles. The appropriate model for the estimation of the value of the economic entity should not only inform about the total value but also indicate the structure of the sources of its creation. Therefore, business valuation methods should take into account as many components of the company affecting its value as possible. Nowadays, the valuation process is already moving in this direction, the example of which is a simultaneous use of, most frequently, asset-based, income-based and comparable company methods to determine the final value of the company. The use of several valuation methods in the course of the applied procedure provides an opportunity to make rational decisions as to the final value of the enterprise [12]. In this paper, the problem areas are analyzed and indicated, which can be useful when building Polish business valuation standards. Undoubtedly, standardization will lead to a reduction in a certain degree of subjectivity, present in valuations. Moreover, valuations made on the basis of the same requirements will become comparable and more easily verifiable in terms of their correctness.

Contemporary realities of the market economy along with the globalization process have caused business valuation to become of fundamental importance for economic processes [13]. Additionally, growing information needs have led to the development of numerous methods of valuation. The enterprise (company) is an economic entity producing and selling goods or services for its own account and at its own risk, an objective of which is to maximize profits. Contemporary management of corporate finance consists in maximizing its value. This is due to the fact that the enterprise, as a separate economic and legal entity, is a particular form of investment. Owners, investing their own capital resources in its economic activities, expect to obtain certain benefits, mainly to multiply the capital invested in this way, which directly leads to an increase in the value of the enterprise they own. At the same time, when recognizing that the economic essence of the issue of ownership is closely linked to the issues of usability and the problem of the monetary value of an object of property, the issue relating to the category of the company’s value appears to be invariably important. Business valuation is the process of estimating the price of assets (fixed and current assets, as well as different intangible assets and characteristics) and benefits achieved due to their effective management [14].

The need for business valuation results from economic development. Along with the globalization of the economy, which is accompanied by an intense flow of capital to a growing number of countries, valuation becomes necessary to the sale, privatization, mergers and acquisitions or creation of joint ventures and many other processes relating to enterprises. It is also important for value management of subsidiaries located in the developing countries. Generally, the objective of business valuation is always to facilitate strategic decision-making in terms of organization, shares or investments. Valuation enables the selection of both ownership and financial options in assets and liabilities. It is actually the opinion concerning the value, prepared by specialized experts, analysts and valuators on the basis of the collected and properly utilized information about the company and the environment of its operations [15]. At the same time, it can be acknowledged that the company’s value is the market measure of the effectiveness and efficiency of actions taken by the enterprise.

The process that aims to determine the value of the company is valuation. The term “enterprise valuation” means that the subject of the valuation is the economically and legally isolated organizational unit, with specific potential in the form of fixed and current assets, as well as different intangible assets and characteristics. Valuation can be treated as the opinion, judgment, estimation of the preciousness of something. According to Miles, valuation is an opinion concerning the value, usually made in writing and, at the same time, it is the process of estimating the value of the cost of the asset, a group of assets or all the assets belonging to the business or the specific investment [7]. However, despite such a crucial function performed by business valuation in the economy, its specificity and essence pose many problems as measures of effective operations, among others. This is related to a variety of conditions and numerous procedures and methods serving business valuation. At the same time, the reasons for the contemporary crisis of confidence in the methodology of business valuation are presented and the directions of future development are indicated, which is of fundamental importance for the operations and opportunities of the conducted business. The essence of the valuation of the company is to give its value as expressed in the specific monetary units using set prices, rules and analyses.

• is an invariably important issue of the economic essence of ownership, which is closely linked to issues of usability and the problem of the monetary value of an object of property,
• is the market measure of the effectiveness and efficiency of actions taken by the enterprise.

The process of the valuation of the company, its specificity and essence pose many problems and controversies. This is connected with the essence of monetary valuation, which is a subjective measure. Then, there are various conditions and numerous procedures and methods for business valuation. The knowledge of the company’s value is of great importance for making strategic decisions concerning characteristic stages of the company’s operation [16]. The essence of the business valuation of the company is to give its value expressed in the specific monetary units using set prices, rules and analyses. Table 1 contains the objectives of business valuation under different conditions, which indicate fundamental importance for the conducted business.

Accurate preparation of the business valuation helps in achieving better trading terms since, in the course of negotiations, it allows for relying on facts and not intuition, feelings and emotions [18]. At the same time, it enables avoiding the situation where the owner’s idea significantly exceeds the actual value of the company or, on the contrary, where this idea definitely does not estimate the company’s value. Therefore, the situation in which the transaction under objective conditions might fail is avoided. There are five functions of valuation resulting from the reasons for carrying it out [19]:

• Advisory (decision-making) function The essence of the advisory function (also known as decision-making) is to provide the necessary information on the value of the company in relation to the intended execution of certain transactions. • Argumentative (justifying) function The implementation of this function consists in the skillful use of information obtained in the course of valuation. This is about the selection of information that will strengthen the bargaining power of the party to the transaction. • Mediation function The mediation function, also known as negotiating, refers to situations where the opinions of parties to the transaction as to the value are significantly divergent. • Security function Its essence is to provide information on the value of the company for the purposes of protection against the adverse effects of disputes arising in connection with the value. • Information function Its essence is to provide information obtained in the process of valuation for the purposes of enterprise management. The recipients of this information are investors, banks, trading partners, customers, financial analysts, authorities at different levels, etc.

After conducting the preliminary analysis of the subject and purpose of the business valuation, it is necessary to choose the method that is the most adequate to the situation of the enterprise and the specificity of its industry. Contemporary realities of the market economy and the globalization process have determined that business valuation is of fundamental importance for economic processes [5]. Additionally, growing information needs have led to the development of numerous methods of valuation. The determinants of the selection of the business valuation method include [20]:

• Valuation objective;
• Who orders (recipient);
• Type of the company due to usability;
• Economic condition of the company and the condition of the environment (economy, industry, region);
• Type, scale and diversity of business;
• Type and number of assets;
• Operation and development prospects of the company;
• Type and quality of information about the company and the market that it is possible to obtain;
• Approaches and types of value in business valuation.

A wide range of practitioners carry out business valuation on a daily basis. Therefore, valuation should be perceived as a practical activity and defined as a way of value (monetary) measurement of the enterprise, i.e., its resources and economic effects of decisions taken.

Fair value is the amount for which an asset can be exchanged if the transaction takes place under market conditions between interested parties who are not related to each other and possess the information that allows for full assessment of the value of the subject of the transaction. At the same time, business valuation is a complex process that is able to illustrate the actual and fair value of the company only if it is carried out in accordance with the so-called characteristics of good (reliable) valuation, which include [21]:

• Compliance of the valuation with the facts;
• Timeliness of data, transparency and relative simplicity;
• Clearly defined purpose of its preparation;
• Being based on the financial data of the company;
• Not being made exclusively on the basis of the value of the company’s assets unless it concerns the so-called liquidation method;
• Taking into account income and intangible factors;
• Taking into account the company’s development forecasts and risk factors;
• Taking into account all relevant information which affects the valuation and is available in the process of its preparation;
• Being objective and reliable.

On the other hand, the selection of the valuation method itself constitutes the most important part of the process of estimating the actual fair value of the company and must be adjusted to the subject of the valuation. Despite the fact that a wide range of practitioners carry out business valuation on a daily basis, this process still requires improvement. Table 2 presents the methods of business valuation the most frequently applied in practice.

Another component resulting in problems in the valuation of fair value is the growing importance of intellectual capital. This is due to global technological and organizational transformations that led to the knowledge-based economy [23]. Intellectual capital, among others, consists of legal assets, technology and relationships with customers, etc. At the same time, among the issues of intellectual capital, there are many ambiguous and various solutions for both theory and practice. Figure 1 illustrates the changes in the significance of assets of enterprises for their valuation.

Therefore, due to difficulties in the valuation of intangible and legal assets, which primarily determine the contemporary value of enterprises, in particular, highly developed ones, in terms of technology, one deals with difficulties in achieving the so-called fair business valuation. The methodology of the valuation of intangible and legal assets is subject to constant changes in search of a universal method. Therefore, along with the aforementioned components, these are the main reasons for the contemporary crisis of confidence in the methodology of business valuation. Therefore, at present, in the subject literature, the conclusion is that in order to make the best possible valuation it is necessary to valuate individual components affecting the value of the company with separate methods, which best reflect the nature of their value. 4. Results

An extremely important factor in the business valuation process is the appropriate selection of methods. This choice is determined not only by the objective of valuation and the situation of the valuated entity but also by the nature of the business and the specificity of areas of its business activity. The economic situation of enterprises, i.e., their market position, status of assets, ability to generate income, are some of the determinants having an impact on the selection of the valuation method. Additionally, in the course of analyses of information concerning the valuated entity and also within the framework of the application of the same method, one deals with the so-called critical points of valuation, i.e., components subjected to the subjective selection. The proper determination of the financial condition of the company can also be a source of differences, depending on the person carrying out the valuation and availability of information [25]. Additionally, it should be noted that each industry is characterized by a certain specificity, which has a large impact on many components that determine the valuation process. The existence of many subjective factors affecting the valuation may lead to abuse, pressure and the desire to influence the experts’ decisions, which results in the distortion of fair value. Therefore, the following should be mentioned as risks and problems to solve in the future:

• Freedom of selection of input data,
• Use of wide subjectivity in the common valuation procedure,
• Subjectivity of selection of valuation methods and internal parameters,
• Lack of coherence in estimation of parameters,
• Lack of legal regulations and standards of valuation.

Therefore, in order to streamline business valuation, there is a need to develop a synthetic and universal yet consistent methodology for the valuation of basic parameters. This also requires the implementation of appropriate regulations or standards concerning the generally accepted methods of business valuation since, depending on the subjective choice of the method by the appraiser, significant differences in the final valuation may be observed with low values of the company [26]. The related works appeared due to the association of a group of specialists and practitioners. One of the tangible results of efforts to eliminate a number of risks is the announced New Interpretative Note No 5—General Principles of Business Valuation [27]. Despite a large number of ways of carrying out valuations and with the high quality of analytical work at the valuation, it should be remembered that a business is worth as much as someone is willing to pay for it. On the other hand, good and factual valuation is essential for preparing oneself for substantive discussions with the buyer. Within the framework of this paper, the essence, objectives and functions of business valuation were determined and the overall classification of valuation methods applied in the practice of economic life was made.

4.1. The Examples of Business Valuation Using the Adjusted Net Assets Method–Case Study

4.1.1. The Practice Example No. 1—Valuations Using the Adjusted Net Assets Method

Under ideal conditions, business valuation would consist in estimating the value of each asset individually and then subtracting all liabilities. The net asset value is then received, i.e., the value less liabilities, adjusted for the book value. For example, such a procedure occurs when valuating enterprises under court cases for division of assets or repayment of some of shares, which is illustrated by the example in the table below (Table 3).

However, for practical reasons, only the most important balance sheet items are often subjected to adjustment, which are also different depending on the valuation objective. Due to the fact that the starting point of the valuation of the company is its net assets, there are many drawbacks to this method, which, to an extent dependent on the resources designed for valuation (mainly cash and time), are adjusted in the course of the valuation. The largest discrepancies between actual and balance sheet values are mostly caused by referring the balance sheet valuation to historical costs and the difficulty in clear classification of some items as equity or foreign capital (reserves, special funds, accruals). Therefore, in order to obtain the real value of the company, it is necessary to make adjustments to balance sheet items. When making adjustments, one should take into account the valuation objective. Other adjustments will be made when the company is purchased for resale, merger or significant reorganization. Adjustments of individual items are also dependent on the type of the conducted activity. The significance of balance sheet items is also assessed in order to reduce the costs of adjustments of less important items. Valuation should start with the determination if all the items are properly reflected in the balance sheet and if the items included in the balance sheet are not just empty records. Obviously, the balance sheet that is the basis for the valuation should be up to date.

The first item is intangible and legal assets. They are usually valuated under the market value; however, when they are unsellable they are valuated at zero. However, there are exceptions, e.g., non-transferable software licenses. In the case of business continuation, they will present measurable value. It should be taken into account that most development costs cannot be activated. Therefore, e.g., in research companies, the relevant adjustment may be essential. Another group is tangible fixed assets. If there is a secondary market for tangible fixed assets, the market price should be taken into account, since depreciation write-offs illustrate formal and not actual consumption of these assets. It is also possible to consider the price of a new fixed asset, taking into account a range of adjustments (due to technological underdevelopment, wear, expert opinion, market conditions, liquidity of the secondary market, etc.). It is also important to include, in the valuation, the fact that market prices may significantly vary depending on the stage of the business cycle [28]. The possessed land is usually underestimated, and making its value realistic results in an increased value of the company valuated. In the case of the right to perpetual usufruct over land, under the item of tangible fixed assets the difference can be found between the first (higher) and subsequent (lower) charges. This difference will be subjected to depreciation write-offs in accordance with the general rules. Therefore, the possession of the right for perpetual usufruct over land will increase the value of the company valuated.

When valuating receivables, despite the existing reserves, lowering adjustments are additionally made, which result from insufficient reserves. It is also necessary to indicate receivables that are not due to specific, already conducted transactions but agreements that cannot be included in the balance sheet on the day of its production [29]. It should be verified if the stocks included in the balance sheet actually exist and if the way of their valuation corresponds to the market value. It is also essential to determine whether the stocks owned by the company are not obsolete, broken or damaged. In the case of receivables, first of all, it should be checked if they are not underestimated and if there are not off-balance sheet obligations and what is the probability of their maturity. Such liabilities will additionally decrease the value of the company valuated. Also, tax liabilities may require adjustments.

While valuating financial assets, the market price of shares and/or stocks should be taken into account. Valuation ought to include the valuation of units in which the specific company has shares/stocks, as long as their value justifies such a way of conduct. When valuating cash, one should pay attention to whether it is cash or whether, under this item, there are also promissory notes and cheques that are associated with risk, which should be considered in appropriate adjustments. Prepayments and accrued income may also require adjustments. Most of all, it is necessary to determine if their allocation over time is correct. In the case of inappropriate estimation, accruals and deferred income may also require adjustments. A typical example would be not taking into account delayed invoices for external services that increase the costs of the specific period. Additionally, when business valuation is made with the intention to merge two entities, there are adjustments to harmonize the accounting approach used in each of the merged enterprises. Also, the need to pay dividends in the future or to recapitalize one of the merging enterprises by the third party will require adjustments increasing or decreasing the entity valuation. Despite the fact that valuation is carried out on the basis of data resulting from the balance sheet, legal regulations or concluded agreements, this method is also not without a certain dose of subjectivity, since the valuator makes the decision on what adjustments and in relation to what assets they will be applied. Each business valuation should be approached individually, since it may turn out that each item in the balance sheet may require adjustments adapting it to the market value. The adjusted net assets method, due to less complicated assumptions necessary for its conduct and adjustment of prices to current net prices, is the most frequently applied asset-based method when making business valuations.

4.1.2. The Practice Example No. 2

The objective of the valuation in the Example 2 (Table 4) is to inform about the value of equity for the previous owner, who is interested in selling his or her block of shares and is planning to use the valuation as a starting point in negotiations.

Downward adjustments adopted in the valuation related to the following assets:

- Intangible and legal assets—this is an integral part of computer hardware. In this case, the equipment along with the software was included under the item of technical equipment and machinery;

- Means of transport—the market value of the means of transport was lower than their balance sheet value by 11.7%. One of the three vehicles had had an accident; therefore, its value was reduced, which resulted in a lower value of the whole item;

- Fixed assets under construction—these were repair expenditures in the company’s main office; the liquidation value of 0 PLN was accepted for the balance sheet after adjustment;

- Long-term receivables—20% was assumed, considering the failure in getting back all the deposits;

- Long-term investments—revaluation of the B2X Ltd. company, in which the Service company has 51% of shares, lowered the value by 24.5% from the balance sheet value;

- Goods and receivables on account of supplies and services—the adjustment indicator of 20% was adopted.

Upward adjustments on the asset side are the following components:

- Real estate (buildings, premises)—revaluation prepared by valuators increased the value by 23.7%, to PLN 5125 thousand and this amount was accepted for the adjusted balance sheet;

- Technical equipment and machinery—were subjected to adjustment on the basis of current market prices and the total value increased;

- Other fixed assets—the appraisal reports produced by valuators indicated a higher value than the balance sheet value.

No adjustments were made to foreign liabilities; therefore, their balance sheet value was assumed in the amount of PLN 7980.28 thousand. The adjusted assets in the amount of PLN 13,924.22 thousand—the adjusted liabilities in the amount of PLN 7980.28 thousand equals the value of PLN 5943.95 thousand. A lot of professionals in the field of business valuation usually end the valuation with the adjusted net assets method at this stage. However, within the framework of the development of the method, it is worth taking into account other components, which may have an impact on the value of the company (value sources), e.g., trademark (brand), know-how, own patents or licenses. In the business practice, the adjusted net assets method usually indicates a lower value of the operating enterprise since it does not include, for example, the value of the company’s contacts or knowledge of employees. Therefore, in the process of business valuation, the value determined by the asset-based valuation method was considered as the minimum value for the seller, which constitutes the company’s assets.

4.1.3. The Practice Example No. 3

The ABC company, among its assets, has:

• The office building worth (according to the appraisal report of 2009) PLN 3 million,
• The production building worth (according to the appraisal report of 2009) PLN 5 million,
• The assembly line of 2003 worth (in the valuator’s opinion) PLN 0.5 million,
• Stocks of materials and products worth PLN 4 million,
• Receivables worth PLN 3 million, PLN 0.5 million of which is uncollectible.

The total value of assets amounts to PLN 15 million (the market value of assets, which may significantly vary from the book value). At the same time, the value of liabilities of the company is two investment loans for a total value of PLN 8 million and liabilities to suppliers worth PLN 3 million. The value of liabilities amounts to a total of PLN 11 million. On the basis of the above, the adjusted net assets value amounts to PLN 15 − 11 = 4 million. The advantages of the valuation using the adjusted net assets method include:

• Objectivity and ease in carrying out by oneself,
• Access only to basic data,
• Taking into account the condition and usability of assets for operation,
• Possibility to compare with the value determined using other methods,
• Possibility to determine the lower range of values in negotiations.
• On the other hand, the primary disadvantages include:
• Not taking into account important components of the company’s value not recorded in the balance sheet, e.g., contracts of the company, knowledge of employees, possessed brands and value of trademarks;
• Possibility to determine only the value of assets in the categories of the so-called material substance, which usually underestimates the value of the operating enterprise.

Undoubtedly, the adjusted net assets method offers the greatest usability in the case of enterprises with a high share of fixed assets in the value of the whole company, i.e., traditional production companies. This is confirmed by the evolutionary history of business valuation methods. At the same time, despite the increasing importance of income-based and comparable company methods, nowadays asset-based methods are still the basis for the estimation of business value.

4.1.4. The Practice Example No. 4

Practical Example number 4 (Table 5) shows the valuation of the enterprise using the income method. This is one of the most popular methods of this type used in practice, namely, Discounted Cash Flows (DCF). For the calculation, the available econometric software used in business valuation practice in the market was applied.

The most common methods currently used in valuation practice are the adjusted net asset method and the discounted cash flow method [32]. They form the basis for determining the explanatory variables regarding assets and income options. To combine the advantages of both methods, mixed methods were created that look for optimal structural parameters.

4.2. The Analysis of Methods and the Valuation Process to Establish the Determinants of Value Subjectivity

Asset-based methods are historically the oldest concept of business valuation, adopting assets as the bases for determining the value. Therefore, the value of enterprises, being the effect of this valuation, is known as the asset value. This means that the company is worth as much as its valuated assets. However, due to the fact that many companies are in debt, one may talk about the gross and net assets value, i.e., the value reduced by the value of debt. In these methods, the market value of the company, understood as the sum of the value of business asset liquidation, is subjected to valuation. The first and simultaneously the simplest valuation of assets is carried out using the net book value method (recordkeeping). The information included in the balance sheet is directly used. The formula for business valuation using the recordkeeping net assets value method:

WP=A−Po=KW,

• WP—business value (net book value),
• A—total balance sheet value of assets,
• P o —balance sheet value of foreign liabilities,
• KW—balance sheet value of equity.

However, the book value of assets and liabilities does not usually equal their market value, which, in the current rapidly changing market conditions—in particular, in the segment of high technologies—may result in significant differences in value, which become unacceptable in order to determine the current fair value. The valuation based on the market value of the possessed assets and liabilities is known as the adjusted net assets method. The formula for business valuation using the adjusted net assets value [33]:

WP=AW−POW=KWW

• AW—total adjusted assets value,
• POW—value of adjusted foreign liabilities,
• KWW—value of adjusted equity.

It is the most common method of valuation of business assets applied nowadays.

The objective of the replacement method is to estimate the total financial outlay that would be needed to restore individual assets of the valuated company. This method is often used by entrepreneurs making a decision on whether it is more profitable to buy a company or build it on one’s own from the ground up [34]. The formula for business valuation using the replacement method (valuation of infrastructural enterprises—the main asset is infrastructure, e.g., power distribution companies) [8]:

WON =WOB ( 1− Zf )( 1− Zm ),

• W ON —net replacement value (the value of the fixed asset, taking into account its physical and moral wear),
• W OB —gross replacement value (the value of the new fixed asset),

Z f —physical (technical) wear indicator,0 ≤ Zf ,

Z m —moral wear indicator (technological change, aging), Zm ≤1.

A specific case is business valuation using the liquidation method (for the purposes of insolvency proceedings), but then fair value is being dealt with.

Income-based methods consist in estimating the market value of the company understood as the sum of net income obtainable from the company in the future. The general formula of business valuation using the income-based method [10]:

WP=∑i=1n at * Dt ,

• t—year of the analysis,
• a t —discount rate for the year t,
• D t —income in the year t.

The formula for business valuation using the discounted cash flow method [9]:

Wd =∑ at *NCFt + RV,

• W d —income value,
• NCFt—net cash flows for the year t,
• RV—residual value.

There are many types of valuations using the DCF (Discounted Cash Flow) method, varying both in the level of detail and the structure of cash flows, as well as the determination of the discount rate. According to the DCF method, the value of the company equals the sum of cash flows discounted at an appropriate rate, which, after cumulation and summing, creates the total cash flow at the disposal of the owners [1].

Asset-based methods, as the oldest concept of the valuation of assets, contemporarily also using the practice of comparable company methods, seem to be to the greatest extent objective and compliant with the intention to determine fair value. On the other hand, income-based methods still require improvement in creating good practices and standards, at least in terms of defining discount rates and the number of years accepted for valuation since, among others, these factors allow for the excessive subjectivity of valuation. Comparable company methods consist in estimating the market value, which is established on the basis of the known sale and purchase transactions. The principle of this method is applied when valuating assets, the prices of which are adjusted to market values. However, the method of comparable company valuation is also the method based on market multiples, which is based on the assumption that the financial market provides the best information for business valuation. The selection of multiples and their use is complicated and causes a lot of controversies, particularly in pursuit of fair value. Therefore, the choice of multiples undoubtedly belongs to the subjective determinants of business valuation.

Mixed valuation methods combine the methods of the valuation of assets with income-based methods. This is due to the assumption that the value of the company is affected not only by its assets but also by the ability to generate income. However, these methods may be unreliable, and this is associated with the possibility of overestimation or underestimation in valuation due to different proportions in the value of assets and profitability in the formulas proposed. Table 6 contains examples of valuation for various mixed methods using the example of actual data presented in the court reports in Katowice and Cracow. The examples were selected because of the same assumptions concerning the valuation using the income-based method. The valuators chose the methods in the following order: the Swiss, German and Stuttgart methods.

Depending on the subjective choice of the method by the valuator, significant differences in the final valuation may be observed, with low values of the company. Therefore, the objective should be to develop standards that will determine acceptable methods (patterns) for specific industries or cases. In the above example, it can be seen that the Swiss method prefers (valuates higher) companies that bring higher income with fewer assets, and therefore prefers companies in which assets are less important, e.g., modern IT companies. While the Stuttgart method will price companies higher having a high value of assets with less importance assigned to income possibilities. In this case, it is possible to choose a method that is more favorable to one of the valuation stakeholders of the company. Most often it is a contradictory interest, because one party wants a higher and the other wants a lower valuation. However, as part of the standard and certain norms, objective valuation of the business should be sought: the so-called fair value price. That is why it is so important to define norms and standards even for specific industries. There are also possibilities to create econometric models that, depending on the changing values of determinants, will create a valuation tailored to specific conditions and types of companies. This is an interesting research direction in this field, which requires numerous numerical calculations to develop appropriate patterns. This clearly shows the need for development and the need to come up with new proposals for business valuation methods, which can be seen today. 4.3. The Methodology of Business Valuation According to the MDI-R Concept

The contemporary methodology of business valuation according to the authors’ concept takes place in accordance with MDI–R (assets, income, intellectual capital and all these components embedded in the market) [35]. Changes in the economic realities of the world (globalization and rapid technological development) have resulted in alterations in valuation methods according to the change in the significance of the components affecting the company’s value. Nowadays, the so-called intangible and legal assets are the most important for the total valuation, which has resulted in the natural development and changes in the concepts of business valuation. Additionally, due to the complexity of issues and the share of all historically known components in the total valuation, undoubtedly, one should look for synthetic and universal calculation models. Mixed methods combine asset-based and income-based calculations. The methodology of MDI–R additionally takes into account comparable company methods, as well as the intangible assets and legal valuation. This results from the assumption that the value of the company is affected not only by its assets, including intangible and legal assets, but also by the ability to generate income and the current market (economic) situation of the environment. The company’s assets are valuated using the following general formula [36]:

M = A − P o ,

• M—the company’s assets,
• Po—foreign liabilities,

where the value of fixed assets can be calculated according to the following formula:

Wst=Wn(1−Zf),

• W st —value of the fixed asset,
• W n —value of a new fixed asset,
• Z f —wear rate of the fixed physical asset, in the range of 0 <= Z f <= 1,

or using the market comparable company method, i.e., the current price of the worn fixed asset in the market.

Income is calculated according to the general concept adopted in income-based methods, in particular, using widely known and utilized indicators, for example:

D=NOPATWACC,

• NOPAT —projected annual net operating profit after tax,
• WACC —discount rate, reflecting weighted average cost of capital of the valuated company.

The DCF method is the most popular income-based method. According to the DCF method, business value equals the sum of discounted cash flows generated by the enterprise, which, after cumulation and summing, create the total cash flow at the disposal of the owners [31].

The MDI–R calculation model takes into account the so-called intangible and legal assets, i.e., human potential, know-how, reputation, the company’s market position, etc. These assets are not subjected to the objective valuation since the assets of this type depend on the subjective behavior of market entities, which decide how much they are able to offer for intangible and legal assets. Therefore, these values are considered (valuated) using the comparable company method, consisting in comparisons with transactions of similar companies in the same industry [34]. Depending on the quantity of available transactions, the formula is the following:

WNiP =( W1 + W2 +…+ Wn )n,

• W NiP —market value of single, specific intangible and legal assets,
• w 1 , w 2 —known market prices of similar intangible and legal assets,
• n —number of transactions of the specific value.

The importance of intellectual capital has increased substantially in recent years since business value is less and less dependent on tangible factors. This is caused by global technological, organizational changes, etc., which have led to the knowledge-based economy [35]. Intellectual capital, among others, consists of:

- Specific knowledge, experience, technology,

- Legal assets (brand, know-how, reputation, etc.),

- Relationships with customers and professional skills.

At the same time, the issues associated with intellectual capital are still not well-known and there are many ambiguous and various solutions for both theory and practice in this field [37].

Undoubtedly, due to difficulties in the valuation of the so-called intangible and legal assets, which primarily determine the value of enterprises, in particular highly developed ones, in terms of technology, one deals with difficulties in achieving the so-called fair business valuation. Nowadays, the conclusion is that, in order to make the best possible valuation, it is necessary to valuate individual components affecting the value of the company with separate methods that best reflect the nature of their value. This rule is obeyed by the MDI–R model, which allows the estimation of the total business value, i.e., takes into account all the components affecting business value while assuming that human capital (knowledge, skills) remains unchanged. Business valuation, in accordance with the MDI–R concept, will present the overall image of changes in the company’s value, as well as the ones resulting from changes in the business environment. Such valuation will be a good measure of the effectiveness of operations conducted in the enterprise. The characteristics of the MDI–R methodology include:

- Taking into account both tangible and intangible assets (WNiP),

- Taking into account the abilities to generate income,

- Taking into account the current situation in the market in which the company operates,

- Taking into account the company’s financing method,

- Taking into account future investment needs,

- Universality—variability of the applied methods in the valuation of specific components, taking into account the conditions for the specific industry.

Therefore, it can be concluded that the MDI–R methodology presents the overall image of changes in the value of the company, as well as the ones that result from changes in the business environment and have an impact on its value. The vast amount of frequently contradictory information concerning economic processes is a characteristic feature of the contemporary knowledge-based economy. Therefore, it is very important to include intangible assets in the valuation, which is an extremely complicated challenge.

The econometric model using an equation (system of equations) helps to explain the mechanism of changes occurring in the studied area. It describes the relationships between given economic quantities. This is a formal mathematical record of existing economic regularities.

Y i = α 0 + α 1 X i1 + α 2 X i2 + ε i.

A basic example of a linear model is also used in the valuation model, although the actual relationship can be more complicated, which evolves through a number of practical studies. Building an econometric model requires not only good knowledge of economic theory and mathematical and economic knowledge, but also knowledge of economic practice. The econometric model should not only have a cognitive value from the point of view of economic theory, but also a practical value, which means that it can serve as a tool of inference in the future.

In the valuation model, the explained value is the business value. The main explanatory variables are the value of company assets and the value of income brought. The random component contains, among others, all variables omitted or errors in measurements and calculations. This property is closer to real variables, to what is happening in the real world. After all, we can never determine perfectly straightforward functional dependencies. The function of such a component is performed by the comparative method, which is used to calculate the explanatory variables MR and DR . That is why the comparative method often appears as a peculiar random component in the econometric model regarding the valuation of enterprises. It allows comparison with transactions (of individual components and also of the most similar companies) that have already taken place on the market. Such a synthetic and universal calculation model is a way to eliminate many risks and problems in business valuation that need to be faced in the future.

As part of the available valuations made by appraisers in the District Court in Katowice and Krakow, a linear regression was performed to estimate structural parameters in the valuation model based on the MDI-R methodology. The companies valued belong to the IT industry. The first row in Table 7 contains estimates of structural parameters, the second row contains standard errors of these estimates. The coefficient of determination (determination) informs about how much of the variability (variance) of the variable explained in the sample coincides with the correlations with the variables contained in the model. It is therefore a measure of the extent to which the model matches the sample. The bigger the regression line, the better suited the data. If the value is between 80% and 90%, then the match is considered good, as in the following example.

MR =( WNiP +A)− Po,

DR =∑i=1n at * NCFt + RV,

WP=0.379* MR +0.621* DR −0.864.

Undoubtedly, structural variables require further practical research. For example, the search for more complex relationships than the linear relationship and the values of the structural variables themselves should be assumed. Nowadays, due to the knowledge-based economy (the greater significance of intangible assets and the smaller value of tangible assets), income value is more important in valuation. This allows for practical calculations in the proposed model, as shown in Table 8. However, there are still and will continue to be industries where the high value of material assets will be necessary for business operation. Therefore, estimating structural variables for these differences will require different equations. This will allow a search for the optimal method of business valuation. Currently, it can be concluded that due to differences in industries (resulting from differences in the value of owned assets), a system of equations will most likely be required that will allow tailoring of the selected equation to a particular industry or type of company.

Summing up the business valuation methods, it can be concluded that the appropriate model for the valuation of the economic entity should not only inform about the total value but also indicate the structure of the sources of its creation. Therefore, business valuation methods should take into account as many components as possible of the company affecting its value, which was proposed in the MDI-R concept. Additionally, the proper valuation should be adjusted to the nature of the company and the specific areas of its business activity. 5. Discussion and Conclusions Within the framework of this article, the essence and manner of business valuation using asset-based methods, which constitute the basic and historically first approach to the monetary business valuation, were determined. Within the framework of the conducted analysis, in terms of the new approach, the reasons for the contemporary crisis of confidence in the business valuation process were presented, including problems and risks occurring in asset-based methods, which, according to the subject literature, are the oldest and most objective foundations for the valuation of a company’s assets. While aimed at solving the existing problems and risks, the possibilities of implementing new rules that will restore the quality and confidence in standards for determining the monetary value of a company were determined. Within the framework of determining the direction towards the accomplishment of the objective, which is the most objective valuation of enterprises, the authors’ proposals of changes were depicted, which at least related to the need to specify certain valuation methods that can be used in relation to specific industries of the economy and categories of components creating the valuated assets. Nowadays, intangible assets and the ways of their use are more important than the category of so-called material substances, which determine the abilities of the company to multiply the invested capital (including, among others, human potential, brand, know-how, etc.). In the study, through the prism of the analysis and classification of asset-based business valuation methods used in practice, it was shown that the adjusted net assets valuation method is currently the best (objective and the closest to the model fair value) solution, which is confirmed by the fact that it is the basis for all valuations in economic practice. On the other hand, within the framework of the accomplishment of the authors’ objective, through the analysis of the literature and practical examples, the need for improvement in the code of conduct and valuation standards was indicated, both in the overall process and within the framework of individual principles applied under asset-based methods, since there is a serious problem in the application of these methods to intangible and legal assets. At the same time, in the study, the factors that can distort the establishment of fair value were presented, while attention was paid to the multidimensionality and complexity of issues of valuation, due to which the pursuit of optimal solutions requires a number of studies of both scientists and practitioners of the discussed subject matter. The research methodology in this study was based on reasoning regarding the methodology of asset-based methods of business valuation and the analysis of practical examples in order to verify the hypothesis of the existence of critical components of valuation, which enable the use of wide subjectivity in estimating the value of assets. The process of valuation of the company, its specificity and essence pose many problems and controversies. This is connected with the essence of monetary valuation, which is a subjective measure. Then, there are various conditions and numerous procedures and methods for business valuation, presented in the study. At the same time, the reasons for the contemporary crisis of confidence in the methodology of business valuation were presented and the directions of future development were indicated, which are of fundamental importance for the operations and opportunities of the conducted business. The study is a part of the discussion concerning the future and development of subsequent solutions aimed at determining, as far as possible, the most objective patterns and standards of business valuation implemented in the practice of economic life. Summing up, it can be concluded that the appropriate model for the valuation of the economic entity should not only inform about the total value, but also indicate the structure of the sources of its creation. Therefore, business valuation methods should take into account as many components of the company affecting its value as possible. Nowadays, the valuation process is already moving in this direction, the example of which is a simultaneous use of, most frequently, asset-based, income-based and comparable company methods to determine the final value of the company. The use of several methods of valuation in the course of the applied procedure provides an opportunity to make rational decisions as to the final value of the enterprise. Such a tool will lead to the desired harmonization of the methodology for estimation of the basic parameters serving valuation with such a degree of quality, which will provide the recipients of this information with a selection of accurate decision-making options in the future. In accordance with the literature on the subject, it was found necessary to search for more perfect methods for optimal valuations of fair value for enterprises. An undoubted contribution is the authors’ proposed hybrid method MDI-R, which draws from existing solutions to improve their functionality and applicability. In addition, the article indicates the possible directions of development of valuation methods and the use of existing valuation models to identify companies threatened with bankruptcy. However, in the case of valuation, it is much more complicated and probably should determine the system of equations that will take into account various industries and economic situations.

Figure 1. The significance of the values of tangible and intangible assets over the years. Source: Own study based on the data: [24].

Source: Own study based on: [7,17].

1 The name of the method comes from the commission called by Union Europeene des Experts Comptables Economiques et Financiers. Source: Own study based on: [22].

Source: Own study based on the opinion of the court expert on behalf of the District Court of Katowice—Wschód in Katowice.

Source: [30].

Source: [31].

Source: Own study based on the valuations by appraisers at the District Court in Katowice and Cracow.

Source: own study.

Author Contributions

Conceptualization, M.K and I.M.; methodology, P.S. and I.M.; software, P.S. and I.M.; validation, M.K. and I.M.; formal analysis, M.K. and I.M.; investigation, P.S.; resources, M.K., P.S. and I.M.; data curation, M.K. and I.M.; writing-original draft preparation, M.K. and I.M.; writing-review and editing, P.S.; visualization, P.S. and I.M.; supervision, P.S. and I.M.; project administration, M.K.; funding acquisition, P.S. All authors have read and agreed to the published version of the manuscript.

The project was financed within the framework of the program of the Minister of Science and Higher Education in Poland under the name "Regional Excellence Initiative" in the years 2019-2022, project number 001/RID/2018/19, the amount of financing PLN 10,684,000.00.

Acknowledgments

Many thanks to Leon Dorozik for scientific support and Janina Miciuła for life support.

Conflicts of Interest

The authors declare no conflict of interest.

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Ireneusz Miciuła 1,* , Marta Kadłubek 2 and Paweł Stępień 1

1 Faculty of Economics, Finance and Management, Department of Sustainable Finance and Capital Markets, University of Szczecin, 70-453 Szczecin, Poland

2 Faculty of Management, Department of Logistics and International Management, Czestochowa University of Technology, 42-200 Czestochowa, Poland

* Author to whom correspondence should be addressed.

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In the modern world, the terms enterprise value and valuation are of great importance. Knowledge about how much an enterprise is worth is of fundamental importance for both the owner of that company and investors when negotiating the price of an enterprise at the time of conducting a commercial transaction. The article presents the goals of the company’s valuation and characteristic stages of the company’s life at which such valuation is necessary. The article classifies the methods of enterprise valuation used today. On this basis, the valuation methodology is presented according to the MDI-R concept (Assets, Income, Intellectual Capital-Market), which in a broad spectrum measures the effectiveness of the company’s operations and, in accordance with the current features of good valuation, aims to determine the fair value of the company. The purpose of the article is to demonstrate the need to improve the code of conduct and valuation standards. As part of the implementation of the objective, multi-faceted and complex valuation issues are presented, as well as factors that may distort the determination of fair value. The methodology of the study is based on inferences about the methodology of business valuation, and verification is based on practical examples, by which a hypothesis on the existence of critical elements of valuation is verified that allows the use of broad subjectivity in estimating the value of assets. At the same time, the factors that determine the possibility of the existence of too wide a subjectivity in estimating assets, which is in contradiction with the features of good valuation, are presented. The attempt is made to draw attention to the threats arising from modern business valuation methodologies and their challenges in the future. Additionally, this article offers the authors’ proposed hybrid method MDI-R, which draws from existing solutions to improve their functionality and applicability.

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If you are evaluating valuation and risk solutions, I would encourage you to check out the vendor’s case studies. While items like brochures, product demos, and website content are useful in helping you understand solution offerings, a good case study will give you valuable insight into real-world use cases and results of the system you might be considering.

If the vendor has a healthy library of case studies available—even better. You should be able to pinpoint at least a couple that will give you a good idea of how other firms solved the same challenges you face. 

At FINCAD, we provide numerous case studies to our clients and prospects. Since we offer different solutions to both buy- and sell-side institutions, we provide a diverse set of case studies that showcase how clients are using our solutions to overcome their biggest valuation and risk challenges. Below are a five popular FINCAD case studies showing how different firm types are getting results with our solutions. Hopefully one (or more) will resonate with you. 

1. Mitsubishi UFJ Financial Group (MUFG) Case Study

Industry : Bank holding and financial services company

Business Objective: Adopt an accurate, efficient solution for CVA reporting, necessary to meeting Basel III requirements

Requirements: MUFG required a CVA provider that not only offered the right technology, but also a complete service for handling the regulatory reporting process from beginning to end.

Results: Using FINCAD, MUFG simplified Basel III CVA reporting, saving considerable time by outsourcing the process to FINCAD’s Professional Services team. Read more about MUFG .

2. Arca Vita Case Study

Industry:  Life insurer

Business Objectives: Introduce powerful analytics libraries, model structured bonds and perform scenario analysis

Requirements: Arca Vita required an easy-to-use and highly reliable software solution that could easily integrate with Excel and other existing systems.

Results: Arca Vita gained flexible curve-building, the ability to constantly monitor portfolios, and perform detailed ALM and scenario analysis. Read more about Arca Vita . 

3. KPMG South Africa Case Study

Industry: Audit, tax and advisory services

Business Objective: Accelerate derivative valuations for banking and corporate clients

Requirements: KPMG required an Excel-based valuation and risk solution backed by a trusted provider that could help them perform timely valuations of complex derivatives.

Results: Leveraging FINCAD’s fast and accurate audit valuation and validation results, KPMG has been able to significantly reduce modeling and computation time, and reliance on internal development resources. Read more about KPMG .

4. First Swedish National Pension Fund Case Study

Industry: Pension fund

Business Objective: Gain access to a powerful analytics library for pricing bonds and yields, able to integrate with an existing investment management application

Requirements: First Swedish National Pension Fund required an analytics library for generating bond and yield calculations. The firm also wanted a solution with a robust development toolkit to help developers build out the application.

Results: First Swedish National Pension Fund accelerated accurate bond pricing and yield calculations, and boosted efficiency through using FINCAD’s prebuilt market conventions. Read more about First Swedish National Pension Fund .

5. Frame Financial Case Study

Industry: FinTech provider of pricing and risk analytics solutions

Business Objective: Provide a key client, Kensington Capital Advisors, and other firms with a solution offering flexible deployment and custom work flows integrated with fast and sophisticated pricing and risk analytics

Requirements: Frame Financial sought a valuation tool providing powerful analytics and flexible architecture for ease of custom solution development.

Results: Using FINCAD, Frame Financial was able to effectively meet the demands of client, Kensington Capital Advisors, giving them the ability to price and analyze diverse portfolios together within a single platform. Read more about Frame Financial . 

Interested in reading more FINCAD case studies?  Check out our full case study library . 

Use Our Resources and Tools to Get Started With Your Preparation!

Valuation cases usually require estimating the price of a firm, patent, or service in the market .

This type of case can either be a subset of an  M&A  case, in which you need to know a company's worth before purchasing, or a standalone case (rare). For instance, “How much is Pfizer worth today?” In strategy consulting, these questions are rather rarely seen. However, cases where you do need to valuate something usually start with “ How much would you pay for… ”

The most common methods of valuating are the Discounted Cash Flow (DCF) and the industry multiple method

As these are still case studies meant to fit in an interview round, the interviewer will very likely not ask you to perform an exact and comprehensive valuation analysis. Instead, you may be required to estimate the worth of a product, patent, or a service. You may also have to judge if an offered price is reasonable.

Discounted Cash Flow method

The first valuation method is the Discounted Cash Flow method. This method shows how much money you would have in your savings account at a certain interest rate in order to provide you with the same annual cash flow generated by the company that is being evaluated. Here, you simply divide projected annual cash flows by a discounted rate (or interest rate). Of course, the discount rate of your savings account will be much lower than that of an investment in a company. This is so because the risk you take putting your money in a savings account is much lower than the risk of investing in a company.

Industry multiple method

The DCF method is limited since it does not take into account additional dimensions other than money (unless you quantify those dimensions into the future cash flows).

Football teams, for instance, are often overvalued compared to their generated returns. For such cases, there is another method called the industry multiple method.

This method allows you to valuate a firm by using a metric known to this company and multiplying it by the associated industry multiple. This can be done for similar players in the industry to assess their relative valuations using  benchmarking .

An example of a multiple ratio is the price-to-book ratio (P/B). This multiple is the ratio of the  actual firm valuation  (based for example on M&A  deals) and the  book value of the same firm  (value of its assets, which can be found in the balance sheet ). If a firm’s assets added up to 200 million, and it was sold for 100 million, the ratio is 0.5 (100 million/200 million). Do this for a set of representative industry players, take the average and you get the average industry multiple. Finally, you multiply the industry multiple with the value of the assets. 

Other commonly used ratios are the price-earnings ratio (P/E ratio or PER) and the EBITDA ratio.

Since you will not be required to calculate the value of an investment on too high a level of detail, it is not necessary to learn values for different interest rates or industry multiples by heart. However, to give you an idea about orders of magnitude:

• A good guess for an industry multiple is EBITDA*10.
• Good guesses for interest rates would range from 3% (inflation) to up to 20% for highly speculative investments.

Key takeaways

• Use the  Discounted Cash Flow (DCF) method to valuate a firm based solely on its expected profits.
• Use the industry multiple method to double-check if the DCF valuation is reasonable. Sometimes other aspects need to be factored in like brand value, customer loyalty, liabilities, etc.
• There are several types of industry multiples to choose from. For more precise valuation, choose more types of industry multiples.

Related Cases

EY-Parthenon Case: Nachhaltiges Geschäftsmodell

FTI-Andersch AG Case: Funkstille – Kommunikationstechnik in der Krise

Forvis Mazars Case: Prüfung der Carvermietungen GmbH

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Valuation: the key to mergers and acquisitions

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Example: Steel Producer Acquisition

Identify the problem, build a problem driven structure, lead the analysis and provide a recommendation.

Valuations are estimates of how much a company will be worth to a prospective buyer . The most important use for valuations in consulting interviews is in cases dealing with mergers and acquisitions . In order to weigh up our options in such scenarios, we need to be able to compare the potential gains or losses associated with various options - and this means we need to make valuations!

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Risky business.

An important point to note straight off the bat is that valuations can only ever be estimates rather than absolute values. Because valuation fundamentally involves making predictions about the future, there will always be an element of uncertainly or risk . We address these sources of risk in some detail - as well as drilling down into many of the other issues here in more depth - in our full length lesson on valuation in the MCC Academy . Here, though, we will have to confine our briefer discussion to the more immediate nuts and bolts of how valuations are made.

We'll explore the theory around valuation through a reasonably straightforward case study which hinges on your valuing a company .

Let's say your interviewer gives you the following case prompt:

"Our client is a steel producer who wants to expand by acquiring their competitor. The competitor offers to sell their plant for $1M. Should our client accept the deal at this price or not?"

Working through this case will provide a great introduction to valuation!

As always, your first step in tackling a case should be to correctly identify the problem . This is quite straightforward given this case prompt. In order to work out whether the client should be willing to pay the $1m asking price, we ultimately need to work out what the steel producer is worth to them . That is, we have to establish the value of this second steel plant to our client, to see whether it is worth paying $1m for .

Varieties of value

This might seem simple enough - however, we have not quite narrowed down the specific problem to be addressed yet. There is an extra layer of complexity to consider when identifying the problem in the case dealing with valuation.

Prep the right way

This is because there is not one single "value" concept for us to reach for. Instead, the word "value" can refer to several distinct quantities, all of which might be of interest in different contexts. These various varieties of value can be somewhat bamboozling at first, as some are radically distinct from other, whilst some are subsets of one another,. We need to be clear exactly which kind of value we are trying to calculate!

In this case study, what we are interested in is the value which acquiring this second steel producer will offer for our specific client. This quantity is referred to as the Asset Value or the Total Enterprise Value (TEV) .

It's all relative...

Note that this value is inherently relative to a particular buyer and will be different for different individuals. In our case, the value of the steel producer will likely be very different for our client, whom is already involved in the industry, to the value which might be derived from a buyer with no existing interests in steel. What we are calculating here is the price which it makes sense for a certain individual to pay for the asset in question .

Now we know exactly which kind of value we are trying to figure out, it's time to get on and figure out how we are going to get to an answer. This means structuring our approach to the problem .

The TEV of the second steel producer can be calculated as the sum of the "standalone" or "market" value of that company plus any "synergies" which emerge when it is combined with our client's operation. Those synergies can be further divided into revenue synergies and cost synergies . Segmenting the problem in this manner yields the following structure:

That was quick enough, but now we need to turn our attention to what the contents of those boxes actually mean...

Standalone Value

We'll deal with synergies shortly, for now, let's focus on how we might calculate the standalone value of an asset - the second steel producer in our example. As per our remarks on the variety of valuations above, there are several ways in which we might go about estimating the standalone value of a company . Three of the most common are:

• Net Present Value This is generally the most robust method of company valuation and is the most commonly used in consulting interviews . This is the method we will use here and we will return to NPV below.
• Multiples This is a method of valuing a company based on the ratio between the company's value and some financial metric such as EBITDA - which stands for "Earnings Before Interest, Taxes, Depreciation and Amortisation", but which we can approximate as cash flow for the purpose of case interview .
• Asset Based Valuation In some cases, the cash flow or similar of a company might misrepresent its value . This might be especially useful in cases concerning businesses like shipping or real estate companies, and especially any companies which might be loss-making, but hold a large volume of valuable assets . In such situations, an asset based valuation calculates the net present value associated with owning individual assets rather than for the company as a whole.

Net Present Value

Let's focus on the Net Present Value, which is more relevant to our example. The NPV represents the value today of the expected future cash flows of the company . This is often referred to as the value of cash flows in "perpetuity".

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Imagine you have the option to buy some bond which yields you a payment of $20 per year every year. The NPV of this bond is the amount which it would be sensible for you to pay today to receive this guarantee of $20 per year in perpetuity.

In our video lesson on valuation in the MCC Academy , we give a full explanation as to the rationale and mathematics underpinning NPV - which can be very important in tacking more complex case studies involving valuation . However, with limited space here, we'll skip straight to the payoff, and note that the NPV can be calculated via the following equation:

Discount rate

A crucial element of the Net Present Value equation is the discount rate (r). The discount rate effectively accounts for the intuitive fact that a dollar today is not worth the same as the guarantee of a dollar one year from now . In normal circumstances, having the same amount of money immediately will be more valuable than having the same amount at some later point in time. For instance, if you are given your dollar right away, you might deposit it in a savings account and earn interest , so you will have a dollar and a few cents more a year from now.

The discount rate will vary for different scenarios and you might be expected to make a reasonable estimation of its expected level for a case. Generally, the discount rate will be higher where a business venture is more risky . This reflects the higher interest rates which will be required by lenders or investors to entrust their money with a business has a higher risk of never managing to pay them back.

As a rule of thumb, you can think about a spectrum of discount rates ranging from 3% for a very safe business to 20% for a very risky venture .

Now, let's turn our gaze to synergies. The possibility of synergies is what will ultimately make our steel producer worth more or less to different buyers , as the new company may interact more or less beneficially with the companies or other assets they already own.

The idea that what one owns already determines how much one is willing to pay for new items if pretty intuitive. Imagine you are selling a collectable item - say a novelty teapot, baseball card or the like. You will obviously get a lot more for it if you find a buyer who needs that item to complete their collection! Higher up the value scale, effects like this are known to cause interesting phenomena in the art market . In particular, there are cases where it makes sense for buyers to pay as much as possible for a painting at auction, as the new market value will increase the prices of the other works in their collection by the same artist by an amount that more than compensates their extra expenditure.

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Returning to our example, we can divide the possible synergies for our client in acquiring the steel producer into two sides - cost synergies and revenue synergies. Let's look at each in turn.

Cost synergies

Cost synergies are realised when the merging of two companies allows for the reduction of costs . Such synergies might be achieved in a few different ways. For instance:

• Merging cost centres Combining two companies can allow for the removal of duplicated structures or staff . In our example, the newly merged company might make cuts to staff in supporting roles such as HR, management or R&D.
• Economies of scale Increasing the size of a business often allows for savings to be made by procuring goods or services in larger volumes - and thus for lower prices . For example, steel manufacture will require both raw materials and fuel/energy and a larger operation buying larger volumes of these might be able to negotiate lower prices. Similarly, the larger company might be able to negotiate lower shipping costs on their outgoing products.

Revenue Synergies

Revenue synergies are realised when combining two companies allows them to increase the revenue they generate . A typical way of deriving revenue synergies is via cross-selling , where two merged companies can sell their products to each other's customers.

In our example, cross-selling would be a strong possibility where our client and the acquired producer have previously specialised in different parts of a full spectrum of steel products which the same customers might be interested in buying. For instance, say our client's company has previously only offered large, unshaped ingots of raw steel and the new producer has specialised in smaller slabs or pre-formed items. The newly merged entity could cross-sell to existing customers who need both kinds of product.

Otherwise, revenue synergy could be obtained even if the two had already been selling the same products to the same customers as the newly combined operation might allow the merged company to fulfil larger orders and so access new customers dealing in larger volumes.

Not always a good thing...

Note that synergies will not always be positive . It might be that merging two companies would actually cause problems. For example, it would be highly damaging from a brand perspective for a health food company to acquire a processed food producer, and could cost them a lot in sales. Brand will likely not be a major concern in the steel industry, but will often be crucial in other case.

With our structure complete, we can proceed to lead the analysis as usual. This will mean asking the interviewer a few considered questions in order to estimate values for the various elements of the structure . Once you have these values, calculating the value of the company is straightforward.

Let's say that, in our example, we valued the steel producer as being worth $1.5m. If there are no other opportunities available with higher values, then we should recommend that our client goes ahead with the acquisition. However, if our client could invest the same $1m in another company or set of assets valued at over $1.5m, then we should advise that they do this instead. Valuation has given us a means to objectively choose between opportunities.

Impress your interviewer

This article is a good primer on valuation, helping you get to grips with the main concepts and walking you through a relatively simple example of a valuation-based case study. However, the problems in your case interview are likely to be somewhat more involved. To get across all aspects of valuation in the detail you will need to land an MBB consulting job, the best resource is the "building blocks" section of the MCC Academy . There, our full length video lesson explores more complex aspects of valuation - including things like a full discussion of risk as it pertains to case studies and of the mathematics around net present value. We do our best, but it simply isn't possible to cram all this material into an article of this size!

For now, though, you should certainly start applying what you have learnt here to practice case studies . Remember to also check out our other building block articles on estimates , profitability , pricing and competitive interaction to learn about more themes that come up again and again in consulting interviews!

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