15 tips for perfect preparation of business valuation by comparative approach

15 tips for perfect preparation of business valuation by comparative approach

The beginning of the year. A time of new resolutions.
In this time of new resolutions, the resolution to perfectly carry out the comparative (market) approach in the process of business valuation fits perfectly. Readers of my note, a little distant from the fascinating issue of business valuation, I inform you that we have three approaches to business valuation:

  • property (cost),
  • income-based,
  • comparative (market).

1. Calculation of multipliers

Calculate the multipliers yourself for use in the comparative approach on the basis of financial data of comparable entities. Remember to be consistent - the method of calculating multipliers for comparable entities must be consistent with the applied profit or balance sheet position of the valued entity. Do not rely in your valuation on multiplier values estimated by external parties. If you do, you are choosing to dance with the devil in the pale moonlight... You will never be 100% sure how the multipliers were calculated and, consequently, you are not able to ensure consistency in the way the multipliers were calculated for the comparables and for the valued entity.

2. Identify comparable entities

Identify comparable entities on the basis of compatibility and similarity of operating activities and scale of operations of the valued entity. Focus on comparable entities characterized by a similar growth rate of sales revenue and operating profit (EBIT) as the valued entity. Remember that value is a function of three parameters - the level of value of assumed economic benefits, the assumed average annual growth of economic benefits (rate g) and the risk of realizability of future economic benefits (cost of capital).

3. Trading liquidity

For comparable companies in the comparable public companies method, make sure that the liquidity of trading in shares is sufficient to talk about the market price of shares - that is, we are dealing with supply and demand. If you consider companies listed on the Warsaw Stock Exchange, note that companies listed on NewConnect and the parallel market (a segment of the WSE's stock market) generally have low trading liquidity.

4. Invested capital multipliers versus equity multipliers

Focus on invested capital multipliers (for example, MVIC/EBIT, MVIC/EBITDA, MVIC/BVIC). Equity multipliers (for example, P/E, P/BV) are dependent on the financing structure (equity versus debt) and do not lead to meaningful results. MVIC is deciphered as Market Value of Invested Capital and generally means the same as EV - Enterprise Value. Consider using sector multipliers that refer to sector-specific quantities - e.g., number of hectoliters of beverage produced, number of subscribers, number of active portal users, level of electricity production. Keep in mind that sector-specific volumes are derived from the performance of total invested capital (equity plus debt), so in fact sector multipliers are a subset of invested capital multipliers.

5. Consolidated versus individual statements

When carrying out a valuation of a group parent, rely on consolidated financial statements. The parent company's stand-alone statements generally do not provide a good basis for the method and may lead to erroneous conclusions.

6. Definition of capitalization

Remember that capitalization, or market value of equity, is the market price per share multiplied by the number of shares excluding treasury shares. Keep in mind that the number of treasury shares from the standpoint of the individual balance sheet is not necessarily the same as the number of treasury shares at the level of the consolidated balance sheet. Of course, in general, the consolidated balance sheet is the basis.

7. Non-operating and unit events

Review the financial statements. In the next step, identify non-operating assets and liabilities, non-operating income and expenses, and non-recurring income and expenses. Then, make the appropriate adjustments to the income statement and balance sheet.

8. Intangible assets

Consider the importance of intangible assets in relation to equity and the importance of amortization of intangible assets in relation to total expenses. If they are found to be significant, consider using multipliers based on EBITA and TBVIC. Let's decipher: EBITA - Earnings Before Interest, Taxes and Amortization; TBVIC - Tangible Book Value of Invested Capital.

9. "Satanic" items

Identify "satanic" items in the financial statements that hinder their comparability, and make appropriate adjustments to the income statement and balance sheet in relation to them. What are "satanic" items? Such balance sheet items include: goodwill, negative goodwill, other intangible assets disclosed in the process of a prior acquisition of another entity, treasury shares, contributions receivable to share capital, grants received for fixed assets recognized in accruals, minority capitals. There may also be other satanic items....

10. IFRS/IFRS versus AA

Fall in love with accounting standards with a special focus on the differences between International Financial Reporting Standards (IFRS) and the Accounting Act (AA). Note that consolidated financial statements under IFRS are required to be prepared by entities with capital groups on the WSE's main market, separate financial statements of companies on the WSE's main market can be prepared under the AA, while financial statements (separate and consolidated) of entities on the NewConnect market do not have to be prepared under IFRS. It is common practice for entities forming groups of companies from the WSE main market to prepare their consolidated and separate financial statements in accordance with IFRS; it is general practice for entities from the NewConnect market and those without groups to prepare their financial statements in accordance with the AA.

11. Acquisitions and divestitures

Find out whether the entity has made a significant acquisition or a significant divestiture during the last fiscal year. Evaluate to what extent the profit category (EBIT, EBITDA, etc.) may be disrupted by such an event. If it is disturbed, make an estimate of the normalized value of the relevant profit category as if the transaction had occurred at the beginning of the fiscal year. Use the normalized size of the profit category for valuation. Note that capital categories (BVIC, TBVIC, etc.) are not subject to disturbance.

12. Interim financial statements

For comparable companies, consider calculating multipliers based on data from interim statements (quarterly and semiannual) if they are more up-to-date than full annual financial statements. Unfortunately, practice indicates that quarterly reports are of poor quality; semi-annual reports reviewed by an auditor are of better quality. Make case-by-case decisions. A good test of whether interim reports can be relied upon is to compare interim reports with full annual financial statements from earlier periods and assess whether the interim was carefully prepared.

13. Valuation date versus financial statement date

In case the valuation date (the date on which the valuation is carried out) does not coincide with the date of the last financial statements, undertake to identify events that may have a significant impact on the value of the company, and that took place between the two mentioned dates. Such events include share capital increases, share repurchases, dividend payments, court cases won/lost, and the acquisitions and divestitures mentioned in the previous section. Make appropriate adjustments to the financial statements for the issues indicated.

14. Value recommendation

Prepare a value recommendation for a given comparative method. Certain multipliers may be more or less appropriate for the specific situation of the valued entity. Although your judgment regarding the degree of importance of particular multipliers may be subjective to some extent, try to justify your choice.

15. Control and liquidity premiums and discounts

Keep in mind that, in general, the comparable public companies method represents value with the liquidity feature and the non-control feature, while the comparable transactions method represents value with the liquidity feature and the control feature. Depending on the subject of the valuation, consider applying an appropriate premium and/or discount regarding control and liquidity issues.

It is assumed that valuation by comparative approach methods is the simplest among the methods used. After applying the above tips, this thesis seems true.

May the Power of perfect preparation of the comparative approach in business valuation in the New 2024 Year be with you. And for all time...


Value Solutions

Cann Advisory sp. z o.o.

Plac Jana Henryka Dąbrowskiego 1

00-057 Warsaw

tel. +48 22 616 20 32

mob. +48 606 234 150

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Cann Advisory sp. z o.o.
Plac Jana Henryka Dąbrowskiego 1
00-057 Warsaw
phone +48 22 616 20 32
mob. +48 606 234 150