Knowing what business is worth and what determines its value is prerequisite for inteligent decision making. John Maynard Keynes said, "There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world."
What is Valuation?
Valuation is the process of determining the “Economic Worth” of an Asset or Company under certain assumptions and limiting conditions and subject to the data available on the valuation date.
Key Facts of Business Valuation:
The Value of a business, by whatever valuation method it is obtained, is not the selling price of the business. Value is an economic concept based on certain data & assumptions, however Price is what a Buyer is willing to pay keeping in consideration the Economic and Non Economic factors like Emotions, Perception, Greed Etc which cannot be valued as such.
The Value is a subjective term and can have different connotations meaning different things to different people and the result may not be the same, as the context or time changes.
Though the value of a business can be objectively determined employing valuation approaches, this value is still subjective, dependent on buyer and seller expectations and subsequent negotiations and the Transaction happens at negotiated price only.
Valuation is more of an art and not an exact science. The Art is Professional Judgment and Science is Statistics. Mathematical certainty is neither determined nor indeed is it possible as use of professional judgment is an essential component of estimating value.
To determine the Value of any business, the reasons for ancircumstances surrounding the business valuation must be pre ascertained. These are formally known as the "Standard of Value" and "Premise of Value".
To be precise, the "Standard of Value" is the hypothetical conditions under which the business is valued and the "Premise of Value" relates to the assumptions upon which the valuation is based .
Standard of Value
The identification of the type of value being utilized in a specific engagement
The price at which the property would change hands between the willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell and both parties having reasonable knowledge of the relevant facts. In this standard of value DLOC & DLOM may apply.
Value to a particular investor based on individual investment requirements and expectations. Control premium & synergy premium is applicable in this standard of value.
The value that an investor considers on the basis of an evaluation or available facts, to be true or real value that will become market value when other investors reach the same conclusion.
Definition varies with the type of transaction and the facts of each case.
For legal purpose courts give fair treatment to parties who seek remedy under law DLOM & DLOC generally not allowed.
Premise of Value
Talks about types of market conditions likely to be encountered.
Two premises of Value
The art of valuation lies in identifying the key value drivers and the key risk areas after analyzing the following :