What is Valuation?

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Published Date:  04-02-2024   Author:   diksha-shastri
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The term ‘valuation’ is gaining popularity in the business world these days. Especially with the immense growth of the startup and business ecosystem in India. As the concept of valuation grows with each passing day, it becomes utterly important for all stakeholders to understand what valuation is in detail. Simply put, Valuation refers to a process. This process is used to determine the monetary value of assets in a business. At a glance, it seems like a pretty straightforward process. However, it holds a crucial position in the domain of finances and business.

In this blog, we try to demystify the growing concept of valuation and the role it plays in the assessment of various business assets. So, let’s dive in!

Definition of Valuation

Valuation, in its essence, is the art and science of assessing the economic value of an asset.

The process of valuation includes the assessment of all different types of assets. These assets can be:

Tangible Assets

A tangible Asset is any property that has a physical existence and you can touch. In the valuation of a business, the following types of tangible assets are included:

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  • Real Estate (buildings, land, office space etc);
  • Machinery and Equipment;
  • Inventory;
  • Vehicles;
  • Furniture and Fixtures;
  • Leasehold improvements;
  • Technology and computer systems;
  • Raw Materials; and
  • cash

Intangible Assets

Apart from the above assets, there are certain properties in a business that do not have a physical presence ie., non-physical. These are the intangible assets. Even though these properties do not have a physical presence, they play an important role in determining the total worth of a business. Let’s see which assets of a business fall under this category:

  • Goodwill;
  • Intellectual Properties – Trademarks, Patents, Copyrights, and Trade Secrets;
  • Customer Relations;
  • Legal Contracts and Agreements;
  • Developed software, algorithms, or technology platforms;
  • Brand Value – social media presence, web presence;
  • Domain Names; and
  • Employee Training and Knowledge

To grow, any business needs to conduct a comparative study of its financial position in the market. Valuation is a process that makes this possible for a business of any size, shape or structure. Moreover, be it a tangible or an intangible asset, the process of valuation helps in putting a price on it.

Also Read: Understanding Inclusions In GST Valuation: A Comprehensive Guide

FAQ: What does having a valuation mean?

The term valuation refers to a process of assessing the monetary values of any asset, business, or financial instrument.

Understanding the Concept of Asset Assessment

To understand valuation fully, it’s essential to understand the concept of asset assessment.

While Valuation is the process used to assign a specific monetary value to assets, the assessment of an asset evaluates and analyses the current and future potential value of that specific asset. Moreover, from the above list, it is quite clear how assets can take many forms in the context of business. So, to carry on asset assessment for a business effectively, you need to have a keen understanding of market trends, industry changes and the specific features of the asset. Hence, simply put, asset assessment is the process of understanding and evaluating the value of your assets.

Asset assessment is an integral part of determining the businesses’ worth and here are the reasons why:

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Financial Reporting

Accurate financial reporting is a must for all types of businesses. Hence, assessing the worth of your assets is important in getting an accurate financial report. Especially when the value of an asset has a direct impact on the balance sheet of the business. For example, if you are using machinery, and its depreciation is affecting your financial statement – it is important to assess its worth. Besides, this will help you in making a wise decision. Moreover, business owners need to paint a clear and transparent picture of their financial positioning to various stakeholders such as investors, creditors, regulatory bodies, etc.

Investor Confidence

Numbers attract Investors, this is the known truth. Hence, you need to provide accurate financial projections to your investors. So, it will paint a realistic picture for the investors and hence, help in winning their confidence.

Strategic Decision Making

Asset assessment is an integral aspect of strategic decision-making. Whether you’re looking to expand your business or enter new markets, there is always a need to know the current position of the assets at hand. Hence, assessing the value of all business assets is vital to making strategic and growth-inducing decisions.

Insurance Coverage

Getting insurance coverage for your business will help you in mitigating risks. However, to check the applicability and coverage, you need to assess your assets. It will show you the real position of your business, and you can plan your insurance accordingly.

Role of Valuation in Determining the Worth of Assets

Valuation probably plays the most important role in establishing the worth of assets. It is only with this process that you can determine the current worth of your company or any other business assets. Besides, it serves as a compass for businesses, guiding them in making informed decisions about their financial health and strategic direction.

So, whether a company is looking to sell a piece of real estate, secure funds, or determine the value of its stock options, valuation is the key that unlocks the door to accurate financial reports and the standing of the company.

FAQ: How is valuation calculated?

This depends on the mode of valuation you choose. However, in a business or company, valuation is calculated based on the company’s share price and its outstanding shares.

Process of Assigning a Monetary Value to Assets

The process of assigning a monetary value to assets is quite complex. Moreover, it depends on various factors such as:

  • Type of asset;
  • Purpose of valuation;
  • Mode of Valuation; and
  • Type of Business.

Hence, the process of assigning accurate monetary value to your assets is asset valuation. This process will differ for all types of businesses. However, here is a brief guide on the general proceedings:

Determine the purpose of the Valuation

As stated before, there are many different reasons why you might be getting your asset valuation. To make the process effective, ideally, you should define the purpose concisely.

Collect Relevant Information

To get the accurate worth of your asset, you will need to ensure that you have all the relevant information. This includes:

  • financial statements;
  • asset performance data;
  • market conditions; and
  • industry trends and other information.

Choose the mode of Valuation

There are three different approaches to valuation methods for both, tangible as well as intangible assets. Let’s delve into the modes:

Income Approach

This approach of assigning monetary value to an asset is most applicable when the asset in question is capable of generating income. Hence, it helps in determining the future profits from the particular asset.

Cost Based Approach

In this approach, the monetary value of an asset is determined by the original cost of obtaining the asset, its adjusted depreciation and more. Hence, the cost-based approach focuses on the expenses you made to obtain the asset. So, while choosing this method of valuation, don’t forget to include all historical costs.

Market Approach

When there is an active market for similar types of assets, like the real estate sector, this market approach for the valuation of assets is applicable. Through this approach, you will have to consider the market value of the assets you procure. Simply put, you compare your assets to the other similar ones in the market and put a monetary value on it on such a basis.

What is Financial Assessment through Valuation in Business?

When you are running a business, assessing it at some point is inevitable. An accurate financial assessment of your business can be done through valuation. From the above modes and different methods of valuation, you can choose the ones suitable for your specific needs. This way of assessing your financial statement through a valuation will show you the real picture of the economic reality of your business.

Apart from this, there can be many reasons why you may need a financial assessment through valuation for your business. Let’s see a few of those reasons in brief:

For Business Planning

A solid foundation is the key to a successful business. Hence, a financial assessment of your business may seem to be fruitful in its early stages. This will help you plan better for the future.

To Secure Funds

Any type of business lender needs to have a clear picture of the business’s financial position. Obtaining funds without giving proper financial projections is also against the norms. Hence, it is important to get a financial assessment of your business through valuation before you start approaching potential investors.

Mergers and Acquisitions

Mergers and acquisitions usually tend to change the entire flow of a business and its operations. Besides, whenever you decide to engage in any merger or acquisition, you must understand the financial position of the target company. This will help you make the process of mergers seamless.

Expansion of Business

Before you decide to introduce new products, new markets, or new services to your business, you must know the exact and accurate numbers for now. Hence, before you decide to downsize or open a new office at a different location, ideally, you should get a financial assessment of your business through valuation.

Compliance to Requirements

Some laws might require you to provide the financial assessment of your business as a mandatory compliance. This is applicable, especially to the needs of the investors or the Registrar of Companies. Missing out on this reason for financial assessment may even lead to hefty penalties.

Business Growth Evaluation

Any business owner starts a business to generate profits. However, once you have spent so many hours and manpower in your business, it is also important to understand the viability of your business. Hence, ideally, you need to get a valuation of your business and assess your finances to track the proper growth of your business.

Risk Management

Risk management and financial assessment go hand in hand. Hence, it is important to identify and manage all the financial risks looming over your business. The process of managing risks is a continuous one, an integral part of business planning strategies.

Litigation and Dispute Resolution

Winning legal battles with strong proof is always a sure-shot way of succeeding. Hence, the accurate financial projections of your business, ie., valuation reports of your business can help you in litigation proceedings. Moreover, it serves as a strong proof even in arbitration and other modes of dispute resolution.

FAQ: Why is business valuation important?

Business valuation is the process that will give the owners and various stakeholders a picture of the whole company or business unit. This financial projection helps in growing the company by securing funds, merger and acquisition deals, building credibility, and legal compliance. These are only a few of the reasons why business valuation is important.

The Importance of Valuation in Business

Accurate valuation of assets is a major aspect of running a successful and compliant business. Especially considering the list above, it is quite noticeable that the financial assessment of assets through valuation helps in the majority of business decisions. Let’s take a look at the points that show how accurate valuation is important for business growth:

  • It allows all stakeholders to make well informed business decisions;
  • You can also use the valuation for setting up or modifying the capital structure of your business;
  • An accurate valuation builds investor faith and helps in securing more funds;
  • A precise report of valuation also helps in complying with the accounting and taxation norms in India; and
  • Accuracy in the financial reports of a company helps in the fair value of instruments like ESOP, Sweat Equity, etc.

Also Read: The Importance of Accurate Valuation of New Products And Services For GST Purposes

Conclusion

In conclusion, everything in this world has its value. When it comes to the dynamic world of business, however, analysing the value of various assets and reporting them becomes ten times more important. That’s when valuation comes into the picture. Hence, if you are a business owner, you must understand the concept of valuation and the need for financial assessment in business through valuation.

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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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