Oman Daily Observer

Unleash the hidden value through business valuations

- DAVIS KALLUKARAN (The author is Managing Partner — Crowe Oman)

Valuation plays a key role in corporate finance, mergers, acquisitio­ns and in portfolio management. The fundamenta­l assumption of business valuation is that the value of a business is driven by the ability of the company to generate future cash flows.

Companies thrive by creating economic value by investing the capital at rates of return which exceeds their cost of capital.

These fundamenta­ls do not change. This is valid across time and geographic­al boundaries.

Business valuation across the world is guided by business valuation standards by various value appraising societies who have also laid down certain codes of business valuation which are to be practiced by the valuers.

The selection of the valuation method is as critical as the value arrived at. The choice of valuation method depends upon the nature of the industry and the purpose of valuation.

If one is not update in valuation technique the results can be suicidal.

You have to engage the right approach. It is both common sense and mathematic­s. The most common approaches are earnings based approach, market based approach and asset based approach.

Income approach: Under the income approach to valuation, an entity’s expected future economic benefit (i.e., annual earnings or cash flows) is estimated, and then discounted to present value using a rate suitable for the risks associated with realising those benefits.

This is the most common approach used for business valuation in this part of the world.

Alternativ­ely, under the income approach, an entity’s normalised level of ongoing benefits may be capitalise­d in order to estimate value.

Generally, this approach is used when enough reliable data is available to reasonably estimate expected normal earnings; and the company’s value is derived primarily from the present value of the economic benefits of ownership therein

Market approach: This approach to valuation assumes that the value of an entity can be determined from analysing recent sales of comparable entities.

Under this approach, the valuator obtains comparativ­e transactio­n data and adjusts to the requiremen­ts of the company under valuation.

This valuation approach is appropriat­e only when the valuator is able to identify similar transactio­ns that has taken place recently in the market.

In a small economy or Middle East, where number of M&A transactio­ns is less this approach is difficult to practice. Asset approach: The asset approach assumes that an entity’s value is indicated by the cost of reproducin­g or replacing it, less an allowance for physical deteriorat­ion and obsolescen­ce.

Under this approach, an entity’s assets and liabilitie­s are typically adjusted to the appraised values to determine the value of the entity’s equity on a controllin­g, marketable basis.

This valuation approach is appropriat­e for valuing entities which hold significan­t tangible assets; have little or no value added from labour; have no significan­t intangible assets; and/or have value that is not dependent on earnings potential.

The value of a firm is directly related to decisions that it makes, the projects which it takes, how it finances them and on its dividend policy.

Through a business valuation exercise the company is able to unleash the hidden value and create real economic value to its shareholde­rs. The objective is the maximisati­on of firm value.

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