At a glance, the process of valuation seems simple. However, it is more than just putting a price tag on your business. The process is very meticulous and involves tons of intricacies. Moreover, there are so many factors such as competitors, market, the inclusions and exclusions of the asset, etc that contribute to that price tag on your asset. An accurate valuation does more than just show you the real worth of your business. It lets you dive deep into the varied factors that contribute to your business’s valuation. With that sort of access, you can easily make way for the future. So, the importance of the stakeholders being aware of the different inclusions and exclusions cannot be more understated.
In this blog, we dive deeper than just understanding valuation. Here, we will focus on understanding the most common valuation inclusions and exclusions. Moreover, when you understand the inclusions and exclusions, it becomes easy to create a balance between the inclusions and exclusions, to get an accurate assessment.
Identifying common factors included in asset valuation
While calculating the worth of something, every component you consider in its calculation is known as valuation inclusion. For example, in a business valuation, its core operational assets and financial projections, cash flow, etc are valuation inclusions. The following are the common factors included in asset valuation:
Assets that you can touch are tangible assets. All such assets that contribute to your businesses day to day operations are common valuation inclusions.
In a manufacturing company, the machine that they use to produce the goods will be a valuation inclusion.
Assets that are not tangible are intangible. Hence, these are assets that you cannot touch or feel. Yet, many times these are more valuable for a business than a tangible one. When these assets are highly influential to your business’s financial position, you need to include them in valuation.
For a technology-based company, its patent grants and software licences, etc. are assets of most value. It is integral to their operations and hence, a core valuation inclusion.
The cash, bank balance, marketable securities, etc that you have are all your financial instruments. The inclusion of these common factors in your valuation will increase the value of your business, showing you its true potential.
An investment firm is a business where the objective is to invest in different stocks. So, for such a business, a portfolio of stocks is a highly common valuation inclusion.
Also Read: What Is Valuation?
Characteristics that help in identifying the valuation inclusions
There are so many different components in a business. So, it can be difficult to identify the inclusions at times. Worry not, though. The following are certain attributes of various factors that will help you identify:
|Attributes of Inclusions
Recognizing typical elements excluded in asset valuation
Not everything in your business will contribute to you figuring out its fair market value. So, just the way you include certain components, you’ll have to exclude some of them. These are known as valuation exclusions. Here’s how you can recognize typical elements excluded in asset valuation.
Certain potential liabilities cannot be foreseen. Moreover, these are based on the happening or non-happening of a circumstance or an event. Hence, it is not viable to keep this in valuation. Exclusion of these contingent liabilities can increase the projection and make your valuation more realistic.
If you own a company that may get into a potential lawsuit, you can exclude the damages or the financial loss from the valuation. However, you can only exclude this if the lawsuit is still in process or may be filed in the future.
Deferred tax refers to an amount of tax that exists, but is liable to be paid in the future. So, these taxes that are payable in the future are usually excluded to avoid complexities.
Any company with a deferred tax liability will exclude it due to the uncertainties associated with it.
One Time Factors
Incomes or expenses that are not recurring for your business will make the valuation unnecessarily complex. Especially if the income or expense is a huge amount. So, ideally, all one-time factors are categorised as valuation exclusions.
The expense behind buying non-core machinery will be excluded from the valuation.
Characteristics that help in identifying the valuation exclusions
The exclusions from valuation are made deliberately. Still, it may get confusing as to which elements to exclude. So, the following list of characteristics will help in recognizing typical elements excluded in asset valuation.
Lack of Impact
As seen above, certain components are immaterial to the company’s main functions. These factors do not contribute to the profitability of your business. Hence, while trying to recognise exclusions, the most important feature you need to look at is its materiality in your business. The basic idea behind this exclusion is that it will have less to no impact on your final valuation.
Co-relation with Business
The final valuation report will show the true monetary worth of your business. To get an accurate assessment, the valuation must include only such factors that are in correlation with your main business activity. For example, if you have a subsidiary company whose operations are completely different and not related to the main business objective, then that subsidiary will have no significant impact on your current business valuation. Hence, the elements must have a direct relationship to your business. When there is no direct relationship, it is ideal to exclude this factor.
Valuation exclusions are often specific and non-ambiguous. What you include in the valuation like the market approach, cost and income generating powers, etc are broad areas and involve a lot of sub-components. However, all valuation exclusions are very specific and to the point. Especially since they are not highly contributing to the business, it is important to consider their specificity.
Balancing inclusions and exclusions for accurate assessment
The key to an accurate valuation is to create a balance between the valuation inclusions and exclusions. When you create a balance between the elements to include and exclude, you will get the true financial worth of the business. Moreover, it is also important to:
- Avoid Overvaluing or Undervaluing your business;
- Facilitate the decision-making process;
- Create a transparency amongst various stakeholders;
- Stay compliant with the laws and regulations; and
- Gain investor trust.
How to Balance?
Carefully considering the following detailed aspects will help in balancing the valuation inclusions and exclusions:
Study the Business Model
Different industries have varied requirements. So, to create a balance between the inclusions and exclusions, you need to carefully study the business model and make decisions accordingly. Simply put, the table below will help in understanding the different industries and their most important asset inclusions.
|Intellectual Property, Software licences
|Stocks, marketable securities, cash, etc
Consider the market conditions
For each specific industry, the market conditions will be deviating. The reasons are the ever-changing demand and supply needs. So, when you try to adjust the value of your assets with the market needs, it is bound to give you an accurate and complete valuation.
The rate of gold jewellery keeps on changing as per the market rate of gold metal.
Ensuring Transparency in Valuation Inclusions and Exclusions
By now, we’ve learnt the important inclusions and exclusions in valuation and how to create a balance between these to ensure true valuation reports are generated. However, many times, even after considering all these aspects, the report is up to the mark. In those cases, there is usually a lack of transparency between the components of inclusion and exclusion. In this segment, we provide you with tips on how to ensure transparency in valuation inclusions and exclusions.
For all business owners, documentation seems like a boring task, but is the key to staying at the top of their game. If you have all the documents organised in an appropriate manner for your business, you will never face difficulty in submitting proofs of how you value an asset, or why an aspect of it was excluded. Moreover, in valuation, while choosing the inclusions and exclusions, you can clearly express your reasons for such inclusions and exclusions, and keep it safe for your records.
At certain times, transparency is the key to accuracy. So, while considering your inclusions and exclusions, getting your points reviewed by an independent valuer is a great way of moving ahead in the game. Moreover, it will also ensure your 360-degree compliance.
Best practices for navigating valuation complexities
Even after a careful consideration of valuation inclusions and exclusions, and balancing them, the process of valuation comes with a lot of complexities. Below is a list of best practices to help you navigate the complexities of the valuation process:
Use Multiple Methods
There are many different methods of valuation. Such as the Comparison method, Discounted Cash Flow method, etc. For a business valuation, it is not possible to get the true worth by solely relying on just one method. Hence, it is important to consider using multiple methods of valuation.
To get a better and more accurate picture of your business as a whole, you may have to make adjustments in the value of some of the assets individually. This includes excluding only certain factors from a particular asset, and more.
Study the Business
When you want to know the worth of a business, you also need to understand the business to its core. So, a common practice for successful business valuation is to understand all the factors of the business. It does not matter if the factor is irrelevant in the present, if it has helped the business reach a certain level, you need to consider studying all its associations.
Evaluation of Risks
Assessment of future potential risk is another key tip that will help you carry on business evaluation with a positive impact. Moreover, when you evaluate certain risks, it can help in figuring out the common valuation inclusions and exclusions.
Consider the Laws and Regulations
The Laws and related rules and regulations govern the entire business ecosystem in India. So, before making any changes in the company, it is vital for you to get up to date with the current compliance requirements as per the law. This is important because any miss-outs in this aspect will lead to hefty financial implications.
To conclude, these are the most common valuation inclusions and exclusions in the business domain. All inclusions and exclusions need to be made with utmost care because they usually have a high impact on the final valuation of the organisation.
What is a valuation inclusion?
All factors of an asset that are purposefully included in determining its value is known as a valuation inclusion.
What is a valuation exclusion?
All factors deliberately left out from the valuation of a particular asset as its exclusions.
How does Exclusion impact valuation?
By excluding certain factors, you can reduce certain expenses or reduce the total value of an asset. This reduction is sometimes crucial to see the true picture of your business. Hence, all exclusions made with care often positively impact valuation.
Does inclusion of certain factors increase the value of a business?
Yes, inclusion of certain factors, such as intangible assets that are core to business operations will definitely increase the value of your business in the final valuation report.