Overview of Business Valuation: formula sheet

Key formulas

Value vs price vs cost

Cost = amount spent (past); Price = amount paid in a deal (actual); Value = estimated worth (opinion)

Use this to answer any 'distinguish' question. Value can differ from both price and cost.

Going concern premium

Going concern value − Liquidation value = value of the business continuing

Indicative idea only. It shows why the premise of value changes the number.

Value of a business (enterprise basis)

Equity value = Enterprise value − Net debt

Net debt = borrowings − cash and cash equivalents. Use when moving between enterprise and equity value.

Four things every valuation must state

Purpose + Valuation date + Standard of value + Premise of value

Missing any one makes the number meaningless.

Purpose-to-value rule

Purpose → premise of value → method → reported value

Choose going concern or liquidation premise from the purpose. Then choose the method. A different purpose can give a different value.

Insolvency comparison

Resolution plan value vs liquidation value

Creditors compare what a plan offers with what liquidation would give. Valuation supplies both figures.

Share exchange ratio

Exchange ratio = Value per share of transferor ÷ Value per share of transferee

Gives the number of transferee shares issued per transferor share in a merger.

Going concern value (income view)

Value = Present value of expected future cash flows, discounted at a rate reflecting risk

Used when the business is expected to continue. Higher risk means a higher discount rate and a lower value.

Liquidation value (net)

Liquidation value = Net realisable value of assets − Cost of disposal − Liabilities settled

Under forced sale, realisable values are lower than under orderly sale. Liabilities are paid in their legal order of priority.

Ordering of premises

Going concern value ≥ Orderly liquidation value ≥ Forced liquidation value (usual case)

This is a general tendency, not a rule. A loss-making business can be worth more in liquidation than as a going concern.

Standard vs premise

Standard of value = what value is measured; Premise of value = assumed use or sale circumstances

Always state both in a valuation answer.

Value as present value of cash flows

Value = Σ [ CFt ÷ (1 + r)^t ]

CFt is expected cash flow in year t and r is the discount rate. Factors raise value by increasing CFt or lowering r.

Capitalisation of earnings

Value = Maintainable earnings ÷ Capitalisation rate

A higher risk means a higher capitalisation rate and therefore a lower value.

Market multiple approach

Value = Metric (such as EBITDA) × Multiple

Industry conditions and sentiment move the multiple.

Asset-based value

Net asset value = Value of assets − Liabilities

Asset quality and liabilities are the factors here.

Net Asset Value (asset approach)

NAV = Value of assets − Liabilities

Assets and liabilities are taken at the fair or adjusted values chosen for the exercise, not always at book values. Per share value = NAV ÷ number of equity shares.

Capitalisation of earnings (income approach)

Value = Maintainable earnings ÷ Capitalisation rate

Use only when earnings are stable. The capitalisation rate is the required rate of return, adjusted for growth where relevant.

Discounted cash flow (income approach)

Value = Σ [CFt ÷ (1 + r)^t] + Terminal value ÷ (1 + r)^n

CFt is the cash flow in year t, r is the discount rate, n is the last forecast year.

Market multiple (market approach)

Value = Comparable multiple × Subject metric

Example: value = peer P/E × the company's maintainable earnings. Peers must be truly comparable.

Choosing the approach

Asset-heavy or loss-making or winding up → asset; stable forecastable earnings → income; good comparables → market

A guide, not a fixed rule. Purpose and data availability decide.

Who must value (Section 247)

Valuation required under the Act → by a registered valuer appointed by the audit committee or, if none, the Board

The valuer must be independent of the company and its related persons, and must follow the notified standards.

Core inputs of every engagement

Purpose + Premise/Standard of value + Valuation date

State all three at the start of the report. Method choice follows from them.

Process sequence

Appointment → Scope → Information → Analysis → Method selection → Computation → Reconciliation → Report

Use this order as a skeleton for any answer on steps in valuation.

Registered valuer structure

Individual → enrolled with a Registered Valuers Organisation (RVO) → registered under an asset class with the authority (IBBI)

Asset classes include land and building, plant and machinery, and securities or financial assets.

Quick revision

• Valuation estimates worth as at a date, for a purpose, on a stated basis.
• Value, price and cost are different ideas. Price is what is paid, value is an estimate.
• The purpose of the valuation decides the basis and method.
• Common purposes: mergers, demergers, fundraising, buy-outs, taxation, insolvency and regulatory needs.
• Going concern premise assumes the business continues. Liquidation premise assumes it is wound up or sold off.
• Always state the premise of value in your answer.
• Factors affecting value include business, industry, economy and deal-specific points.
• The three broad approaches are asset, income and market.
• No single method suits every business or purpose.
• The valuer must be independent, follow the applicable standards and document the work.
• Valuation reports state the date, purpose, basis, assumptions and limitations.
• In case answers, link each point to the facts given.

Common mistakes

• Treating value, price and cost as the same thing Fix: Define each separately. Cost is historical, price is actual, value is estimated.
• Saying there is one true value of a business Fix: Say value depends on purpose, date, perspective and assumptions. A range is acceptable.
• Treating value and price as the same thing. Fix: Say value is an analytical estimate and price is the negotiated amount. Valuation informs the price.
• Giving one value for every purpose. Fix: State that the purpose and premise decide the value. Contrast going concern with liquidation.
• Treating standard of value and premise of value as the same thing. Fix: Write one line for each: the standard says what value is measured, the premise says the assumed circumstances of use or sale.
• Assuming going concern value is always higher than liquidation value. Fix: Say 'usually'. A business with losses and valuable land may be worth more if broken up.
• Listing factors without explaining their effect on value. Fix: Add a reason for each factor: say whether it changes cash flows, risk or assets.
• Mixing up internal and external factors, for example calling debt level external. Fix: Ask whether management can change it. Capital structure is internal. Interest rates are external.
• Treating approach and method as the same thing. Fix: Write the approach first, then the method under it: income approach, DCF method.
• Using book values for NAV without adjustment. Fix: State that assets and liabilities are restated to fair value where required, and use the figures the question gives you for adjustment.

Exam tips

• Open every answer with a definition that includes purpose, date and basis of value.
• For 'distinguish' questions, use short bullet points for each term and add one rupee example.
• Write each type of value as its own line so the examiner can tick it.
• In case-based questions, name the purpose first, then pick the basis of value, then conclude.
• Do not quote a single value as the truth. Use words like estimate and range.
• Open every answer by naming the purpose, because the paper is case-based.
• Cover at least four purposes in a general question: deals, fundraising, insolvency, tax and compliance.
• Tie each purpose to a protected party. This turns a list into analysis.