What Are Some Common Valuation Errors?

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Published Date:  04-02-2024   Author:   diksha-shastri
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You purchase any product, property or service after contemplating its value and worth. So, what happens if you make a purchase and find that the product is not worth its value? You feel scammed. Similarly, in business, investors will invest only after knowing the accurate value of a business. Moreover, knowing the true and correct business valuation is also important for many other reasons. However, the process of valuation is very complex. For any person carrying on this process, the utmost care and high-skill development is necessary. One miss out in the report generated post-valuation can impact the business and its owners very negatively. Hence, it is very important to conduct the valuation process and prepare its report with utmost care and consideration. 

Before you start with your business valuation, it is also vital that you know some of the most common errors that valuers and business owners make, so you can avoid them. In this blog, we will focus on understanding the most common valuation errors. Let’s get started with Asset Valuation. 

Identifying Errors in Asset Valuation

Asset valuation helps in figuring out the value of any one or two assets, or even a group of assets. When you are considering the asset valuation for your business, it will include a large group of assets. The process of compiling all the different types of assets such as machinery, real estate, stock, Intellectual properties, etc is difficult and any small error may lead to giving the wrong results. Let’s delve into the considerations that will help you in identifying the errors in asset valuation. 

Overlooking Market Tendency

The tendency of market trends is that it keeps on changing. So, before you get the asset valuation, you must look out for the product positioning in the market. For example, if you have a gold necklace and you want to know its value, you’ll have to weigh it and multiply it by the existing price of gold in the market. However, the value of gold keeps on changing due to a lot of factors. Hence, to know the exact value of the necklace, you will have to keep track of the market trends, actively. If you want to sell it, you can sell it on a day when the valuation is higher. This is why overlooking these market tendencies is considered as an error in asset valuation. Let’s see how it impacts your valuation process in this table.

Error in Valuation Overall Impression
Ignoring Market Position Overstating or understating the value of an asset
Absence of Industry Specific Research Missing out on the specific benefits or any insights particularly tailored for an industry. 

Reliance on Precedent Data

Everything is bound to change with time. So, even though precedents are an integral aspect of getting to know the current valuation, they cannot be the only factor you use in determining the value of your assets. Doing so will result in inaccurate results and may lead to serious consequences for the owner. Moreover, with time, the following factors change;

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  • Industry trends;
  • Market Position;
  • Demand;
  • Versatility of Market; 
  • Laws and Regulations that govern a specific industry; 
  • Global Events; and 
  • More

So, a precedent report or any data from the past is only useful and accurate in the present if none of the above-listed factors have changed in that period. If either one has been affected with time, and has upgraded, it will render the past data irrelevant. Moreover, with the lightning speed at which technological developments are moving forward, historical data and reports gain irrelevancy quickly. So, it is ideal that you check all current trends and technological developments before completely relying on the data for valuation.

Error in Valuation Overall Impression
Excessive Reliance on History Improper picture of the current developments and trends
Disregarding New Gen Technology Acts as a deterrent to move forward and face other technically sound competitors

Neglecting Elements of Risk

There are always elements of risk attached to a thing. The case for assets is also similar. Assets depreciate with time, however, many other elements of risk will lead to a sudden shift in the value of an asset. For example, the reduction in the price of gold during the global pandemic. Many factors will help you in assessing the risks associated with your assets. These include the stability of the market, natural or man-made disasters, global economic situation, etc.

Error in Valuation Overall Impression
Non consideration of risk Failing to calculate the possibility of losses
Lack of Risk Reduction Less security during market instability

Inconsideration of Intangible Assets

When conducting asset valuation, you are bound to include tangible assets. However, a very common error in asset valuation is in consideration of the value of intangible assets like intellectual property and goodwill of the business. These assets are equally important for your business. In fact, many times, patent grants are the most attractive factor for investors these days. Everyone wants to invest in something unique and innovative.

Error in Valuation Overall Impression
Missing Out Intangible Assets Failure to know the exact and accurate asset valuation

Common mistakes made in financial valuation

In this segment, we will talk about the common mistakes that business owners and individuals make in the process of financial valuation. Managing finances becomes very easy when its true worth is clear. Moreover, when the investors are aware of the clear picture of your business’s finances, it will help in gaining their faith. So, to get a clear and precise picture of your finances, avoid the following common mistakes made in financial valuation:

Prejudiced or Biassed Views

Many people are overly optimistic and similarly, many are overly pessimistic. This can negatively impact your financial evaluation if you make assumptions and projections either way. While making any assumptions or taking any decisions related to valuation, it is very important to keep the values as close to the real picture as possible. Personal point of view and bias in favour or against the valuation material is bound to leave a negative impact on your report. This is one of the most common mistakes made in financial valuation. 

Complicated Financial Regime

While considering the income-based approaches for financial valuation, making the model very complex may seem like a good idea, but usually creates unnecessary complexities. For example, many people make the mistake of combining two income-based methods for financial validation. A common mistake in financial valuation is combining the capital cash flow (CCF) method with the discounted cash flow (DCF) method. Especially because both of these methods are extremely complex. Moreover, when you try to combine two different things that are completely exclusive of each other, the results you derive will never be accurate or in your favor. 

Error in Due Diligence

Due diligence is a tool. It helps in knowing the entire picture of a business. Moreover, the most amazing thing about due diligence is that it shows you exactly what is lacking in your business or finances. Hence, it is a common practice to carry on due diligence before going through with the valuation of finances. So, when there is an error in due diligence, or if it is not complete due diligence, it won’t give you appropriate results in your valuation either. 

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Ignorance of the Laws

With time, the rules and regulations are also bound to change. So, as a stakeholder in a business or a company, you must keep up with these changing dynamics of the laws and rules. Failure to do so always comes with challenging consequences. This applies even to your valuation process. If you miss out on acting according to the updated laws, your valuation report is not going to be at par with accurate results. 

Additional Pitfalls and Challenges in the Valuation Process

Until now, we have focused on the most common and challenging mistakes that valuers tend to make in the valuation process. We have covered both common mistakes in financial valuation and errors in asset valuation. However, apart from these complex mistakes, there are certainly other challenges you may face in the valuation process due to some very menial miss-outs. Let’s discuss these pitfalls and challenges in the valuation process: 

Calculation Errors and Typos

Proofreading important documents and reports is something a person should never avoid. It seems unnecessary and like a waste of time, until the valuation report comes out with a huge gap in your actual position and the answers derived. Small typos or calculation errors can have a huge impact on the final result. 

Failure to convert currency

Many times, in international transactions, people tend to make errors in converting the currencies as per the ongoing rates. Hence, you must keep track of the conversion rates and use them accordingly before the final valuation. 

Mistakes in MS Excel 

MS Excel is often used for calculations and making routine and repetitive tasks easier. However, it only works best when you enter the correct formulas. Making mistakes in entering Excel formulas is a very common error. Hence, before you finalise anything you do on Excel, ensure that the formulas applied are to your needs or not. 

Changing Information Sources

For the Comps method of valuation and many other different methods, you need to do a lot of market research. To serve this purpose, you will come across many different sources of information and data. To get an accurate report, you need to choose your sources of information very carefully. This might seem trivial, but can create a big pitfall in the process of valuation. 

Strategies for minimizing valuation errors

Now it is clear to understand that avoiding common valuation pitfalls is a must to run a successful and growth-centric business. Many different strategies for asset valuation and financial valuation help in minimizing errors. So, let us delve into these strategies that will help you make your business stronger: 

Keep Up With the Trends

To get accurate results with changing times, it is important to stay aware of the surroundings. So, you need to keep up with all the different trends in the market. Moreover, as stated, you also need to be up to date with the different laws and regulations that govern you. This is bound to curb the simple mistakes you tend to make due to ignorance or unawareness. 

Proofreading is for the Champs – Keep at It

One of the common mistakes was also small typos and spelling errors, or calculation mistakes. These can easily be resolved, if you focus and proofread all the important data and the reports that you work around. 

Use a Combination of Past and Present Data

A bridge between the past and present will take you where you want to reach. As we saw earlier, relying solely on past data is an error in valuation. However, solely relying on the data of the present is also similarly difficult. Hence, you need to ensure that you are integrating the present and precedent data to get optimized results for your business valuation. 

Analyze Risks Thoroughly

In life or business, ignoring the risks is never a clever idea. This is also applicable to your valuation process. Include all the risk factors after adequate research to ensure that the results you are getting also prepare you for unforeseen circumstances in the future.

Conclusion

Valuation is an integral part of your business, it will help you plan out probably the next five years for your growth. So, without a doubt, it becomes necessary to avoid all common valuation errors. This blog covers the majority of the mistakes and pitfalls that you are bound to make. So, use it as your checklist before you move on with the valuation process, to get the real picture of your business.

Also Read: Why is Valuation Important?

FAQS

  • What are valuation problems?

When the valuation report generated does not show accurate results, it may be due to a valuation problem. Common problems in valuation include typos, using historical data, not conducting proper research, etc. 

  • What is an example of a valuation error?

Relying on back-dated information is one very common example of valuation error. You can avoid it by staying on trend and at the top of your game. 

  • How can you ensure error-free valuation?

To ensure that your valuation does not come out filled with errors, you need to make sure that you are double-checking and fact-checking every bit of information that you provide for this purpose. 

  • What is the impact of an error in asset valuation?

The impact depends on the significance of the error you made. However, usually an error in your valuation process will render the report meaningless, if the error is highly significant, like not including intangible assets, etc.

  • Is overstating future cash flow projections in valuation wrong?

Yes, it is not only wrong, but ideally, overstating your numbers just to show a picture that does not exist, is bound to create liabilities for you. So, before you go ahead with a valuation process, ensure that you are not overstating your future projections. 

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Diksha Shastri

Diksha is a seasoned writer of all things Law, Finance and Business. She aims to make things easy for the readers.

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