Why is Valuation Important?

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Published Date:  04-02-2024   Author:   diksha-shastri
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Every piece of thing or material in this world has a value. In certain situations, it becomes necessary to know the value of a thing. In the business domain, a monetary value applies to various assets and instruments. This process of placing monetary value on an asset, through different methods is known as valuation. Valuation is a part of asset management, for everyone. So, no matter who you are, if you hold assets or properties, you need to know why valuation is important. There’s no need to worry, you’re at the right place! In this blog, we will cover various aspects of valuation, showcasing its relation to assets and determining their properties. 

Apart from this, we will also discuss the role of asset valuation and its influence on the overall financial health of your business. So, let’s delve into the depths of valuation and its significance for business owners. 

What is Asset Valuation and its significance?

In simple terms, proper asset valuation is the foundation for financial decisions. Hence, this concept of asset valuation refers to the putting a monetary value on an asset or a group of assets. However, this assessment happens after careful consideration of many different aspects. The various aspects that form a part of proper asset valuation are:

  • market conditions, 
  • comparable sales, 
  • cash flow projections, and 
  • the condition of the asset itself.

It is not a hidden fact that there are different types of assets, and such assets may need to undergo different valuation processes. These assets may include:

  • Real Estate;
  • Intellectual properties; 
  • Machinery; 
  • Cash;
  • Accounts Receivables; 
  • Goodwill;
  • Marketable shares and securities; 
  • Employee Skills; 
  • Software and hardware you develop; and
  • More

Every part of your business that helps in creating your profits is somehow an asset in the context of valuation. So, when you want to get a transparent framework for your business or other assets, as a whole, proper asset valuation becomes very important. With accurate valuation, you can make a lot of well-informed decisions for your personal and business growth.

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Also Read: What is Valuation?

FAQ: Is valuation for business necessary? 

In some conditions, getting a valuation might be a legal necessity, like when securing funds through the issue of securities. In other cases, it may not be mandatory. However, to maintain transparency, valuation is necessary for your business. 

What is the role of valuation in financial decision-making?

The most common reason that business owners in India opt for business valuation is to raise capital. In this scenario, accurate and proper valuation helps business owners gain the faith of their investors by providing them with a transparent picture of their financial projections. Now that we understand the significance of a business valuation in financial decision-making, let’s also delve into the various roles it plays to make the process easier: 

Valuation as a Compass

In a business, you can make financial choices from a wide range of options. So, to meet your business goals and your vision, you need to have the bird eye’s view of the right direction.  Here, valuation acts like a compass. It helps in determining the direction in which you’d like to move forward. Using the accurate valuation as a compass can help in choosing the right direction for your financial position of the business. Moreover, this is not just applicable to the business owners but to the investors as well. 

Proof of Business Performance

People enter into business for profits. Be it a business owner, or an investor, everyone wants to generate profits from the hard work they do. To obtain the actual numbers and calculate the actual profits, you need to evaluate the performance of the business. Timely and accurate financial reports generated through the various modes of valuation can act as strong proof of the performance of your business. Moreover, when you keep track of the different valuation reports, it will also help you discover the pain points and improve the overall business performance. 

Helps in moving forward

To move forward, you first need to evaluate your current position. This applies to both, life and business. An accurate valuation is significant because it will help you weave a path that reaches your end business goal. 

Identify Gaps

An accurate and precise report, prepared after considering the trending market conditions, will also help you in identifying certain internal or external gaps that may help in improving the financial situation of the company or business. 

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An Indication of Personal Growth

The total value of your business also affects your net worth. Hence, knowing the business valuation, you can also try and take an estimate of your personal growth. 

Importance of Accurate Valuation

From the above points, it is quite evident that valuation plays an irreplaceable role in making financial decisions. However, it is also important to note that valuation is not just important for businesses. It is also a mode of assessing an individual’s financial projections. So, one by one let’s see how valuation is important for business owners and individuals alike.

Importance of accurate valuation for businesses

Accurate valuation helps businesses in various scenarios. Let’s take a look at a few of those:

Preparing well-informed strategies

For the growth of a business, you need to see its potential. An accurate valuation report will help in understanding the potential of an existing business and hence, allow you to make informed decisions about different business strategies.

Making Negotiations Easier

Negotiations are a game of power. When you are dealing with complex issues of mergers, and acquisitions, or even dealing with onboarding new investors. Having the true picture in your hand with the help of accurate valuation, will enhance your negotiation power in such dealings. 

Attracting Investors and Lenders

Raising capital is an integral aspect in direct correlation to the growth of your business. To scale a business to a certain level, there will come a time when you have to raise funds. When the startup ecosystem is at a boost, it is very difficult to find investors and lenders. Hence, in situations like these, providing your investors with an accurate financial projection through an appropriate valuation will help in attracting your investors, and getting them on board. 

Calculating Fair Compensation

Since valuation is directly about the financial position of the business, it also affects the securities. Hence, an accurate valuation will help in determining the shares and other details for various shareholders. Moreover, in startups, ESOPs are a major aspect of employee compensation. Valuation accuracy also helps in setting up the appropriate ESOP Pools. 

Transparency in Financial Reporting

An Accurate valuation will ensure that the financial statements of your business also accurately reflect the business’s economic reality. This helps in building trust among investors, creditors, and regulatory bodies.

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

Importance of Accurate Valuation for Individuals

Valuation is one of the most classic and simple ways to figure out the worth or estimate thereof of any asset or a group of assets. As stated above, accurate valuation is important for individuals also. It helps in determining many important factors of an individual’s financial position. Let’s take a look at those: 

Provides Financial Clarity

An accurate valuation will help the individual get a realistic picture of their wealth, including assets, investments, and liabilities. This can also help you in figuring out how to plan your future financially, as an individual. 

Impacts Investment Decisions 

Accurate valuation is an integral aspect of your investment portfolio as an individual. It allows you to make informed decisions about buying, selling, or holding investments, optimising the potential for returns and risk management.

Fair Pricing in Real Estate Transactions

Whether you decide to buy or sell a house, or any other type of property, an accurate valuation will help in raising a fair market price for your property.

Checking Insurance Coverage

When you know your worth in monetary value, it becomes easier to plan your insurance coverage accordingly. So, an accurate valuation of personal wealth helps in getting accurate insurance coverage. 

Future Financial Planning

An accurate valuation will help you in paving the way to a financially secure future. This includes your will and estate planning, matrimonial disputes, charitable contributions and tax benefits and more. 

What is financial reporting?

The process of recording expenses and maintaining track of all financial transactions of a company is known as financial reporting. As a company owner you can prepare either monthly, quarterly, or yearly financial reports. Besides, financial reporting is an integral part of maintaining the accounting data for the company. A complete financial report consists of the following: 

  • Financial Statements: balance sheet, profit and loss account, etc;
  • Discussion and Analysis of the Management;
  • Auditor’s report; and 
  • Other supplementary information. 

Apart from this, the major inclusions of a financial report vary based on your country’s laws. In India, you also need to submit these reports as and when requested by the MCA. This helps in enabling transparency in business operations. Hence, having accurate information in these reports is a must.

How does Valuation impact financial reporting?

Valuation can be one mode of ensuring that your financial report is showing the actual numbers. The reason behind this impact is the fact that valuation influences the assets, securities, liabilities, and plans of your business. Let’s see other ways in which valuation impacts the financial report as well as the overall financial health of the company. 

Accuracy in financial statements

Your P&L and Balance sheet evaluate your assets and liabilities. Getting an asset valuation will help in drafting accurate financial statements. 

Recognise all sources of income

An income-based approach to valuation will help you realise various sources of income. 

Power of Intangible Assets

Though not visible, intangible assets are still an extremely important part of your business. Valuation will help you realise the true standing and worth of your intangible assets. 

Proof of Regulatory Compliance

Companies need to comply with laws and submit their financial reports to the authorities. Now, in case of any discrepancies, the authorities may feel the need to go through the accuracy of your reports. In such times, the backing of an honest and reliable valuation report will save you from being liable for non-compliance.

FAQ: What is valuation’s contribution to the overall financial health of a company? 

Answer: An accurate and reliable valuation report will help you raise more capital, stay compliant with the laws, figure out any loopholes in your current position, work it out, and help you make informed decisions. Hence, it is good to state that valuation significantly impacts the overall financial health of a company. 

Conclusion

In conclusion, it is vital to know where you stand before moving ahead. In the business domain, valuation shows you the exact current position of your business. Based on this, you can pave the way to scale your brand. 

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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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