Business valuation is the process of deciphering the current value of an entire business. This process includes asset valuation, financial valuation, and valuation of other securities. When you decide to go ahead with valuation, you need to understand that it involves a lot of components from the business. Especially considering that it is a complex procedure that helps in making very important financial decisions. Moreover, it involves a lot of internal and external components. We are aware that all rules have exceptions, and so does the process of valuation.
Before proceeding with valuation, it is vital to understand the components that are excluded, and the reason for such exclusion. Through this blogpost, we discuss all the components of a business that are excluded at the time of valuation. So, get ready to take a deep dive into the different types of valuation exclusions.
Exclusions in the Asset Valuation Process
Asset valuation is a significant aspect of any business’s overall comprehensive valuation. It not only includes the assessment of tangible assets, but intangible ones as well. In asset valuation, the cost of buying the asset, its income generation power, its depreciation, market situation, etc. are all included as important components. Now, let’s see the exclusions in the asset valuation process.
Non Viable Assets
A business has a ton of assets. However, not all assets will help in determining the current value of the business. For example, land that you own and want to use when the business expands is not an asset that is helping your business in any way currently. So, in this scenario, while considering asset valuation, such a non – operational asset will be excluded from valuation. The reason is, that it does not add up to the business value now and is present for a future purpose. Only assets that are important for the day-to-day business operations in the present are a part of the valuation process.
Assets with Indefinite Life
Certain assets do not have a definite life span. For example, consider the goodwill of a business or its trademark or trade secrets. These intangible assets do not have an exact duration or lifespan, and they are in the business for a long period. However, it is possible that their usage in business operations may decrease with time and the growth of the business. However, it will continue to exist after serving its purpose. Deciding whether to include these assets in the valuation or not will depend on an assessment of these assets through a test known as the impairment test. Lastly, even certain business registrations and licences form a part of valuation exclusion.
Components omitted when determining asset value
Certain components of an asset of a business render its valuation inappropriate. So, these components are omitted when determining the asset value, with deliberate intention. The table below contains a brief explanation of these valuation exclusions and the reasons for said exclusions.
| Valuation Exclusion | Reason for exclusion |
| Goodwill | The undefined lifetime makes it redundant at times |
| Additional Real Estate | When it is not used in day to day activities |
| Empty Land | Does not contribute to the company’s operations |
| Investment Securities | Not integral to the business and only held for the purpose of investments |
| Machinery not in Use | Equipments that do not contribute to the productions, and is not in use for ideal business purpose |
| Certain Subsidiaries | Business units that do not contribute to the main business activity |
| Potential Liabilities | Certain liabilities that may or may not happen based on certain circumstances |
| Obsolete Raw Material | Certain inventory items that exist but cannot be used in the product anymore. For example, a VHS tape. |
Also Read: Examples Of Exclusions In The Valuation Of Goods And Services
Why are certain Factors excluded in focused valuation?
Focused valuation of a business revolves around deriving its true operational value. So, all operational factors are excluded in focused valuation. Focused valuation is necessary for a business in a lot of instances. There are many different reasons why these factors are excluded in focused valuation. Here are a few of those reasons:
Focus and Clarity
A business undergoes valuation when there is a dire need for fundraising, merger and acquisition, purchasing any integral asset, making investments, etc. So, the purpose of valuation must be kept in mind. At certain times, losing focus is easy when you have a lot on your mind. But, always remember to keep a clear mind of the purpose of valuation. This will help in determining the factors to exclude from valuation. These valuation exclusions will help in deriving an accurate and precise valuation report for the specific purpose you had in mind.
Precision in Report
The more precise your final valuation and its report, the more beneficial it becomes for you. This precision in the final report can only be achieved by excluding certain unnecessary factors during valuation. It helps in achieving the true operational value of your business. Moreover, a precise and to-the-point report is bound to spike the interest of your investors.
Avoiding Contortions
The inclusion of one-time events or incomes that will not recur, can lead to the creation of contrasting views in the report. Moreover, it can distort financial projections, future cash flow predictions, and more. Hence, such information or one-time data must always be a factor that is excluded from your valuation. To get a report that is projecting your business’s true financial worth, you need to take careful steps in certain factors to avoid contortions and distortions.
Improved Comparison
There are two different types of comparisons that the process of valuation facilitates. It includes internal comparison with the data of the past and the second one involves the comparison of your company’s data to that of other similar existing companies, ie., your peers and competitors. When the factors included in your report are not similar to the peers or your previous data, comparing the projections is not appropriate. Hence, if your valuation is widely based on the Comps method, you will have to maintain a basic similarity in the factors that you include and exclude in the valuation process of your assets. Moreover, while considering this aspect of valuation methodology, you also need to exclude all the different factors that are not comparable.
Understanding Cash Flow
When a valuation aims to know the earning capacity of a business, it is ideal to exclude expenses not related to cash for the business. These expenses are non-cash expenses and hence excluding them from asset valuation will help in deriving the true cash-earning capacity of a business.
Easy Communication
Exclusion of certain factors usually helps in making the process of communication easier for the stakeholders. When you want to catch the attention of your investors, keeping your valuation report free of unnecessary data and information is the key to it. Moreover, this ease of communication will build a better relationship between various stakeholders. And, when the foundation is strong, the growth of an organisation becomes inevitable.
What are common exclusions in financial valuation?
Till now, we have covered a lot of exclusions of the asset valuation process. However, now it’s time to focus on the exclusions in financial valuation. The financial valuation happens to evaluate the monetary value of a company or a business. In this case, you will have to exclude some common factors to get the monetary value. Let’s see the exclusions in detail:
Unquantifiable Assets
Certain assets that do not have a physical presence, ie., intangible assets are not quantifiable. For example, the goodwill of a business or the value of the copyrights owned by the business, etc. In these cases, it is ideal to leave these assets out of the picture while going forward with financial valuation. The reason behind this is, the fact that financial valuation needs to revolve around the monetary values of a business. So, when monetary value is not quantifiable, you need to exclude it from the financial valuation.
Contingency in Liabilities
Some liabilities may or may not arise upon the happening of a certain event. These are contingent liabilities. There can be no absolute prediction of the loss of income that these liabilities may lead to. So, without a doubt, you need to keep it as a part of your valuation exclusions.
Corporate Social Activities
CSR activities are done to pay back to the environment. However, many times it is not easy to put a number on the environmental liabilities that arise from the business. So, such liabilities should also be excluded from the financial valuation of the business.
Cost of Restructuring
While considering the income-based approach of valuation, all the costs that are not integral to the business operation are excluded. For example, if you have spent around 1,00,000 Rs. to restructure your business this year, you must exclude it from the financial valuation. The reason is the fact that these costs usually happen once in a lifetime. So, these details render the valuation invalid. So, this is one of the common exclusions of financial valuation.
Deferred Taxes
Many times, the taxes on a business may be applicable, but not payable at the present date. In this situation, there is no fixed date as to when these taxes will be payable. So, such tax implications are factors excluded from financial valuation.
Risk of Future Litigation
Business owners often know when a lawsuit might fall upon them. Yet, these future potential lawsuits do not have a definitive timeline or any loss defined to it. So, these aspects are not integral to knowing the businesses’ wealth in the present. Hence, you must exclude these factors from the valuation.
Understanding Valuation with Deliberate Exclusions
Deliberate exclusions refer to certain factors that are left out of valuation on purpose. There are many different reasons why various internal and external factors are left out of this process. Let’s understand it more precisely with the table below:
| Deliberate Exclusion | Logic |
| One time Charges | Since these are not recurring expenses, it may negatively impact the final result of valuation. |
| Non operational Costs | Expenses that are not core to the business operations and do not contribute to its position. |
| Employee Stock Option Plan (ESOP) | When it is not reflected in the financial statement, ie., the balance sheet. |
| Economic Circumstances | At a macro level, certain economic circumstances do not have an impact on your business. So, it is better to exclude them. |
Conclusion
In any process, certain factors play a very important part. Whereas, some things do not need to be included. For example, we all know that one bad apple in a basket can probably ruin all the apples. So, it is always advisable to remove the one rotten apple. Similarly, when you remove certain unusable factors from valuation, you will get the perfect valuation report. With that said, it is also important to know that all valuation exclusions need to be done only after a thorough study of the business and the purpose of valuation. Most importantly, pay attention to all exclusions, so you leave no stone unturned in deciphering your business’ operational value.
Also Read: What Are The Exclusions In Valuation?
FAQs
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Are certain factors deliberately excluded from valuation?
Yes, certain aspects of your business are excluded from its valuation to derive its true operational value. These include non-core business units, goodwill, intangible assets, ESOPs, and more.
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Why are some components not included in the valuation?
Some components of your business do not actually contribute to its day-to-day functioning. So, including these factors can result in wrong projections. Hence, it is important to exclude these factors from your valuation.
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What are valuation components?
Valuation components refer to the components of a business that are included in the valuation process. It includes finances, assets, and other materials, such as stocks, investments, etc.
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What is excluded from valuation?
Any asset or liability where you cannot put a monetary value or if it’s not core to the operations of your business is excluded from valuation.
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How can I decide what to exclude from the valuation?
You can decide what to include and exclude in your business valuation through a study of the method you are wanting to use for valuation, and the purpose of valuation. The purpose of valuation usually plays the most important role in figuring out its components.
