What is Valuation?

(source:
corporatefinanceinstitute.com)
Valuation refers to the
process of determining the
present value of a company
or an
asset. It can be done using
a number of techniques.
Analysts that want to place
value on a
company normally look at
the management of the
business, the prospective
future earnings, the
market value of the
company’s assets, and its
capital structure
composition.
Valuation may also be used
in determining a security’s
fair value, which depends
on the
amount that a buyer is
ready to pay a seller, with
the assumption that both
parties will enter the
transaction.
During the trade of a
security on an exchange,
sellers and buyers will
dictate the market
value of a bond or stock.
However, intrinsic value is a
concept that refers to a
security’s
perceived value on the
basis of future earnings or
other attributes of the
entity that are not
related to a security’s
market value. Therefore,
the work of analysts when
doing valuation is to
know if an asset or a
company is undervalued or
overvalued by the market
What is Valuation? (source:
corporatefinanceinstitute.com)
Valuation refers to the
process of determining the
present value of a company
or an
asset. It can be done using
a number of techniques.
Analysts that want to place
value on a
company normally look at
the management of the
business, the prospective
future earnings, the
market value of the
company’s assets, and its
capital structure
composition.
Valuation may also be used
in determining a security’s
fair value, which depends
on the
amount that a buyer is
ready to pay a seller, with
the assumption that both
parties will enter the
transaction.
During the trade of a
security on an exchange,
sellers and buyers will
dictate the market
value of a bond or stock.
However, intrinsic value is a
concept that refers to a
security’s
perceived value on the
basis of future earnings or
other attributes of the
entity that are not
related to a security’s
market value. Therefore,
the work of analysts when
doing valuation is to
know if an asset or a
company is undervalued or
overvalued by the market
What is Valuation? (source:
corporatefinanceinstitute.com)
Valuation refers to the
process of determining the
present value of a company
or an
asset. It can be done using
a number of techniques.
Analysts that want to place
value on a
company normally look at
the management of the
business, the prospective
future earnings, the
market value of the
company’s assets, and its
capital structure
composition.
Valuation may also be used
in determining a security’s
fair value, which depends
on the
amount that a buyer is
ready to pay a seller, with
the assumption that both
parties will enter the
transaction.
During the trade of a
security on an exchange,
sellers and buyers will
dictate the market
value of a bond or stock.
However, intrinsic value is a
concept that refers to a
security’s
perceived value on the
basis of future earnings or
other attributes of the
entity that are not
related to a security’s
market value. Therefore,
the work of analysts when
doing valuation is to
know if an asset or a
company is undervalued or
overvalued by the market
OVERVIEW

What is Valuation?

 Valuation refers to the process of determining the present value of a company or an assets.
(Present value (PV) is the current value of a future sum of money or stream of cash
flows given a specified rate of return. Present value takes the future value and applies a
discount rate or the interest rate that could be earned if invested
 It can be done using a number of techniques. Analysts that want to place value on a
company normally look at the management of the business, the prospective future earnings, the
market value of the company’s assets, and its capital structure composition.
Valuation
 It may also be used in determining a security’s fair value, which depends on the
amount that a buyer is ready to pay a seller, with the assumption that both parties will enter the
transaction.
During the trade of a security on an exchange, sellers and buyers will dictate the market
value of a bond or stock. However, intrinsic value is a concept that refers to a security’s
perceived value on the basis of future earnings or other attributes of the entity that are not
related to a security’s market value. Therefore, the work of analysts when doing valuation is to
know if an asset or a company is undervalued or overvalued by the market.
Valuations can be performed on assets or on liabilities such as company bonds. They
are required for a number of reasons including merger and acquisition.

MODULE 1. OVERVIEW OF VALUATION TECHNIQUES

OBJECTIVES:
 Identify the relevance of your accounting skills in valuation
Accounting Skills
Analytical Skills
Accounting work requires a meticulous, detail-oriented eye. Accountants must sift through hefty
financial records to ensure every detail is accurate and current. Otherwise, their analysis may yield
inconsistent results.
Adaptability
Like the frameworks guiding taxes and financial reporting, the accounting profession constantly
changes and evolves. Accountants should always be prepared to adapt to changing standards and
protocols, as well as technological advances, workplace dynamics, and new platforms for client
interaction.
Time Management
Many accountants work on multiple projects at once. The ability to multitask and effectively manage
one’s time ensures accountants can meet deadlines and provide satisfactory results for their clients.
Bryant agrees that time management is essential for successful accounting careers.

Industry Knowledge
accountants should have extensive knowledge about financial statements and how they work.
Technical expertise in specific areas of accounting can shed light on different topics. For example,
ledger skills understanding credits and debits, while standard reconciliation skills help accountants
differentiate between ledgers and trial balances. Furthermore, sharpen understanding of Generally
Accepted Accounting Principles (GAAP), Securities and Exchanges Commission reporting, and initial
public offerings. He adds that most prominent accounting firms offer skills training in different
competency areas.

Spreadsheet Proficiency
Today’s accountants rely on a variety of software programs to complete different tasks.
Spreadsheets are particularly common, It urges prospective accountants to become familiar with
Microsoft Excel and other spreadsheet platforms. “No matter what kind of accounting you’re going
to pursue,” “spreadsheets will be an intimate part of your everyday life, and your ability to prepare
them efficiently and accurately will set you apart from other new hires.” Additionally, he encourages
accounting students to take a Microsoft Excel course and create spreadsheets in their spare time to
track personal budgeting or investments.

 Describe the asset and equity valuation

 An asset-based approach is a type of business valuation that focuses on a company's
net asset value. The net asset value is identified by subtracting total liabilities from
total assets.
 Identify what and when to use the valuation methods appropriately
Methods of Valuation
 Market Capitalization. Market capitalization is the simplest method of business valuation.
...
 Times Revenue Method. ...
 Earnings Multiplier. ...
 Discounted Cash Flow (DCF) Method. ...
 Book Value. ...
 Liquidation Value.

 Distinguish absolute versus relative valuation (refers to methods of valuing equity stock)
 Absolute valuation models calculate the present worth of businesses by
forecasting their future income streams.
 There are two types of absolute valuation models: Dividend Discount
Model and Discounted Cash Flow Model.

 Relative valuation approach provides information on how the market is currently valuing
securities. The bad news is that it is providing information on current valuation.

There are underlying assumptions in performing valuations:

Basic Principles of Accounting

one should be equipped with analytical skills. These skills should not only be on intelligence and
reasonable ideas, good recommendations and excellent analysis. It should also be anchored with the
principles that guide accountants to provide ethical practices for decision making.

The accounting principles are concepts that serve as basis in preparing and interpreting the financial
statements. These are the basic foundations that guide prepares into presenting the financial reports to
the users and the users to be confident of what they read.

The Conceptual Framework of Accounting specifically mentions the underlying assumption of going
concern which contemplate the realization of assets and settlement of liabilities in the normal course of
business.

The basic concepts or principles of accounting are:

Going Concern Assumption

 The going concern principle, also known as continuity assumption, means that a business entity
will continue to operate for at least another accounting period. This principle is the reason why assets
are generally presented in the balance sheet at cost rather that at fair market value and long-term
assets are included in the books until they are fully utilized and retired

Accrual Basis of Accounting

The accrual basis of accounting means that the financial statements are prepared where income
and expenses must be recognized in the accounting periods to which these are incurred. This means
that revenue or income is recognized when earned regardless of when payment is received, and
expenses are recognized when incurred regardless of when these are paid

Examples:
a. XYZ Company rendered
repair services to a client
on October 10, 2019. The
client paid
after 90 days which is
January 9,2020. The income
will be recognized when the
service
has already been rendered.
Hence, the income should
be recognized in October,
2019
even if it has not yet been
collected as of that date.
b. Burgis Company received
its electricity bill for the
month of December, 2019
on January
5, 2020 and paid it on
January 31,2020. When
should the electricity
expense be
recorded? The electricity
expense shall be recorded
in December, 2019 even if
the bill
has been paid and received
in January, 2020 because
electricity consumption
pertains
to the month of December,
2019.
Examples:

a. XYZ Company rendered repair services to a client on October 10, 2019. The client paid after 90 days
which is January 9,2020. The income will be recognized when the service has already been rendered.
Hence, the income should be recognized in October, 2019 even if it has not yet been collected as of that
date.

b. Burgis Company received its electricity bill for the month of December, 2019 on January 5, 2020 and
paid it on January 31,2020. When should the electricity expense be recorded? The electricity expense
shall be recorded in December, 2019 even if the bill has been paid and received in January, 2020
because electricity consumption pertains to the month of December, 2019.

Accounting Entity Concept

The accounting entity concept recognizes a specific business enterprise as one accounting entity,
separate and distinct from the owners. In other words, a company has its own identity set apart from its
owners and can represent its own self.

For example, if Naruto Company buys a vehicle to be used as delivery equipment, then it is
considered a transaction of the business entity and not by the owner even if the owner is the signatory
of the transaction. However, if Mr. Zen, owner of Naruto Company, buys a car for personal use using his
own money, that transaction is not recorded in the company's accounting books because it is not a
transaction of the company. If the money used to buy the car is company’s funds, then the payment will
be treated as company advances to the owner which can be deducted from owner’s future dividends or
share in profits.
Time Period
The time period
assumption, also known as
periodicity assumption,
means that the life of
an enterprise is subdivided
into time periods
(accounting periods), which
are usually of equal
length, for the purpose of
preparing the financial
statements. An accounting
period is usually a
12-month period – either
calendar or fiscal. A
calendar year refers to a
12-month period ending
December 31 and fiscal
year is a 12-month period
ending in any day of the
year except
December 31
Time Period

The time period assumption, also known as periodicity assumption, means that the life of an
enterprise is subdivided into time periods (accounting periods), which are usually of equal length, for the
purpose of preparing the financial statements. An accounting period is usually a 12-month period –
either calendar or fiscal. A calendar year refers to a 12-month period ending December 31 and fiscal
year is a 12-month period ending in any day of the year except December 31

Monetary Unit Assumption

This means that transactions and events when recorded in the books of accounts shouldbe
measured in monetary terms.

The monetary unit assumption has two characteristics – quantifiability and stability of
thecurrency. Quantifiability means that records should be stated usually in the currency of the country
where the financial statements are prepared and stability means that the purchasing power of the said
currency is stable or constant and that any insignificant effect of inflation is ignored.

There are other principles derived from the above concepts, like: matching principle, revenue or
expense recognition principle, historical cost principle, consistency, materiality, neutrality or
completeness. The financial statements should possess the above attributes or concepts so that these
can be reliable to decision makers.

Asset and Equity Valuation

Valuations can and should be used as a powerful driver of how you manage your business. The
purpose of a valuation is to track the effectiveness of your strategic decision-making process and
provide the ability to track performance in terms of estimated change in value, not just in revenue.
There are two common valuations: (1) Asset valuation, and (2) Equity valuation
What is Asset Valuation?

This pertains to the value assigned to a specific property when a company or asset is to be sold,
insured, or taken over. The assets may be categorized into tangible and intangible assets.

Asset valuation is the process of determining the fair market or present value of assets, using
book values, absolute valuation models or comparables. The assets may include investments in
marketable securities like stocks and bonds; tangible assets like buildings and equipment; or intangible
assets like brands, trademarks or patents.

What is Equity Valuation?

Equity valuation is a general term which is used to refer to all tools and techniques used by
investors to find out the true value of a company’s equity. It is often seen as the most crucial element of
a successful investment decision. Every participant in the stock market either directly or indirectly makes
use of equity valuation while making investment decisions. The users of equity valuation are the small
individual investors who make up the vast majority of stock market investors, the government and
institutional investors and entities that hedge(limit) funds.(Hedge accounting is a method of accounting
where entries to adjust the fair value of a security and its opposing hedge are treated as one. Hedge
accounting attempts to reduce the volatility created by the repeated adjustment to a financial
instrument's value, known as fair value accounting or mark to market)

Valuation Methods

When valuing a company as a going concern, there are three main valuation methods used by
industry practitioners: (1) DCF analysis, (2) comparable company analysis, and (3) precedent transactions
As shown in the diagram above, when valuing a business or asset, there are three broad categories that
each contain their own methods. The Cost Approach looks at what it costs to build something, and this
method is not frequently used by finance professionals to value a company as a going concern. Next is
the Market Approach, this is a form of relative valuation and frequently used in the industry. It includes
Comparable Analysis Precedent Transactions. Finally, the discounted cash flow (DCF) approach is a form
of intrinsic valuation and is the most detailed and thorough approach to valuation modeling (Intrinsic
value is a measure of what an asset is worth. This measure is arrived at by means of an objective
calculation or complex financial model, rather than using the currently trading market price of that
asset.)

DCF Analysis

Discounted Cash Flow (DCF) analysis is an intrinsic value approach where one forecasts the
future business free cash flow and discounts it back at present day. It is the most detailed of the three
approaches, requires the most assumptions, and often produces the highest value which also often
result in the most accurate valuation.

Comparable Analysis

Comparable company analysis, also called trading multiples or public market multiples, is a
relative valuation method in which you compare the current value of a business to other similar
businesses by looking at trading multiples like P/E, EV/EBITDA, or other ratios. Multiples of EBITDA are
the most common valuation method. This is the most widely used approach, as they are easy to
calculate and always current. (Knowing the EBITDA margin allows for a comparison of one company's
real performance to others in its industry)

Example of Comparable Table

Precedent Transactions
Precedent transactions
analysis is where you
compare the subject
company to other
businesses that have
recently been sold or
acquired in the same
industry. These transaction
values include the take-
over premium included in
the price for which they
were acquired.
Precedent Transactions

Precedent transactions analysis is where you compare the subject company to other businesses
that have recently been sold or acquired in the same industry. These transaction values include the take-
over premium included in the price for which they were acquired.
Leveraged Buyout (LBO)
A leveraged buyout model,
or an LBO, is a type of
company acquisition where
total
acquisition proceeds are
financed with a substantial
portion of borrowed funds.
There are two
parties involved in a
leveraged buyout – the
buyer company & the
target company. In LBO, the
acquiring company finance
the acquisition with a mix
of equity (usually the down
payment) and
debt (for the remaining
balance). The target
company’s assets serve as
security or collateral for
the debt.
In LBO, the acquiring
company usually targets
companies that are in
trouble but have
valuable market, maybe
financially or have incurred
heavy losses. After the
buyout, the
acquiring company
channels the management
and technical expertise and
funds to the target
company. Sometimes,
employees are allowed to
participate in the LBO
through an employee
ownership plan, which may
provide tax advantages and
improve employee
productivity.
Leveraged Buyout (LBO)
 A leveraged buyout model, or an LBO, is a type of company acquisition where total acquisition
proceeds are financed with a substantial portion of borrowed funds. There are two parties involved in a
leveraged buyout – the buyer company & the target company. In LBO, the acquiring company finance
the acquisition with a mix of equity (usually the down payment) and debt (for the remaining balance).
The target company’s assets serve as security or collateral for the debt.

In LBO, the acquiring company usually targets companies that are in trouble but have valuable
market, maybe financially or have incurred heavy losses. After the buyout, the acquiring company
channels the management and technical expertise and funds to the target company. Sometimes,
employees are allowed to participate in the LBO through an employee ownership plan, which may
provide tax advantages and improve employee productivity.

Example:

Barbers Corp. wants to buy Gupit Corp without investing a lot of capital. The value of Gupit
Corp. is Php2,000. Barbers Corp. invests Php200 of its own equity and for the remaining Php1,800, it
borrows at an interest rate of 5% per annum.

In the first year of operations, Barbers Corp earns Php200 (10%) from the cash flow of Gupit
Corp. Now the total value of Gupit Corp. is Php2,200. Barbers Corp. repays its interest on debt for Php90
(5% of Php1,800) which is an expense to the company. Thus Barbers Corp is leftwith Php110 available
for equity shareholders. Barbers Corp earns Php110 on its original investment of Php200.00 which is
55% return on equity on this transaction (Php110/Php200).

How much return Barbers Corp. would have earned had it financed the entire transaction by
equity? To acquire Gupit Corp, Barbers Corp. has to invest Php2,000. In the next one year, Barbers Corp.
earned Php200.00 from the cash flow of Gupit Corp. thus, its total return is only 10%
(Php200/Php2,000).

We can therefore say that the returns on leveraged buyout are much higher than financing the
buyout by equity alone.

Absolute and Relative

Valuation
There are two basic
methods of valuing equity
stock: (1) the absolute
evaluation and (2)
relative evaluation. These
methods have its own
advantages and
disadvantages so one has
to
make wise decisions on
what techniques to use for
the asset valuation.
There are two general
approaches in valuation
techniques: (a) the
discounted cash flow
valuation techniques,
where the value of the
stock is estimated based
upon the present value of
some measure of cash flow,
including dividends,
operating cash flow, and
free cash flow; and
(b) the relative valuation
techniques, where the
value of a stock is
estimated based upon its
current price relative to
variables considered to be
significant to valuation,
such as earnings,
cash flow, book value, or
sales.
These approaches and all of
these valuation techniques
have several common
factors:
(1) all of them are
significantly affected by the
investor’s required rate of
return on the stock, (2)
all valuation approaches
are affected by the
estimated growth rate of
the variable used in the
valuation technique like
dividends, earnings, cash
flow, or sales.
Absolute and Relative Valuation

There are two basic methods of valuing equity stock: (1) the absolute evaluation and (2) relative
evaluation. These methods have its own advantages and disadvantages so one has to make wise
decisions on what techniques to use for the asset valuation.
 There are two general approaches in valuation techniques: (a) the discounted cash flow
valuation techniques, where the value of the stock is estimated based upon the present value of some
measure of cash flow, including dividends, operating cash flow, and free cash flow; and (b) the relative
valuation techniques, where the value of a stock is estimated based upon its current price relative to
variables considered to be significant to valuation, such as earnings, cash flow, book value, or sales.

These approaches and all of these valuation techniques have several common factors: (1) all of
them are significantly affected by the investor’s required rate of return on the stock, (2) all valuation
approaches are affected by the estimated growth rate of the variable used in the valuation technique
like dividends, earnings, cash flow, or sales.

Absolute Valuation Techniques

Discounted Dividends

The most straightforward measure of cash flow is dividends because these are clearly cash flows
that go directly to the investor. However, this dividend technique is difficult to apply tofirms that do not
pay dividends during periods of high growth, or that currently pay very limited dividends because they
have high rate of return of investment.

Discounted Residual Income

This cash flow measure is the operating free cash flow, which is generally described as cash
flows after direct costs and before any payments to capital suppliers are made. The discount rate
employed is the company’s weighted average cost of capital (WACC).

Discounted Free Cash Flow

Another cash flow measure
is free cash flow to equity,
which is a measure of cash
flows
available to the equity
holder after payments to
debt holders and after
allowing for expenditures
to maintain the company’s
asset base. Since these are
cash flows available to
equity owners,
the appropriate discount
rate is the company’s cost
of equity.
Relative Valuation
Techniques
A possible problem with the
discounted cash flow
valuation models is that it is
possible
to derive intrinsic values
that are substantially above
or below prevailing prices.
The relative
valuation techniques
advantage over discounted
cash flow valuation is that
they provide
information about how the
market is currently valuing
stock at several levels that
is, the
aggregate market,
alternative industries, and
individual stocks within
industries
The relative valuation
techniques are
appropriately considered
under two conditions: (1)
there are good set of
comparable entities
wherein comparable
companies are similar in
terms of
industry, size, and risk, and
(2) the aggregate market
and the company’s industry
are not at a
valuation extreme where
they are not either
undervalued or overvalued.
Discounted Free Cash Flow
 Another cash flow measure is free cash flow to equity, which is a measure of cash flows
available to the equity holder after payments to debt holders and after allowing for expenditures to
maintain the company’s asset base. Since these are cash flows available to equity owners, the
appropriate discount rate is the company’s cost of equity.

Relative Valuation Techniques

A possible problem with the discounted cash flow valuation models is that it is possible to derive
intrinsic values that are substantially above or below prevailing prices. The relative valuation techniques
advantage over discounted cash flow valuation is that they provide information about how the market is
currently valuing stock at several levels that is, the aggregate market, alternative industries, and
individual stocks within industries.

The relative valuation techniques are appropriately considered under two conditions: (1) there
are good set of comparable entities wherein comparable companies are similar in terms of industry,
size, and risk, and (2) the aggregate market and the company’s industry are not at a valuation extreme
where they are not either undervalued or overvalued.