Institute of Cost Accountants of India
WIRC Bulletin - June 2018

Demystifying the Valuation conundrum by CMA S K Gupta

Demystifying the Valuation conundrum by CMA S K Gupta

                               Towards becoming a professional Valuer

                        Demystifying the Valuation conundrum

                                               CMA Dr. S K Gupta

                                AIHP – Director ( Corporate Affairs )

                                  E – Mail : [email protected]

 We have always been intrigued by magic.It is not often that a magician reveals his secrets. However, in the movie, Now You See Me, the magicians actually revealed the secret to their performance.  In an early scene of the movie, a volunteer from the audience at a magic show in Las Vegas is transported across the globe into a bank vault in Paris.  Later, it is revealed that the volunteer was not actually transported, but simply dropped through a trap door into an exact replica of the bank’s vault.  In a similar way, business valuation seems quite mysterious and misty to the people.

Financial projections, discount rates  are few examples of key inputs to valuation that seem puzzling.

  • How does the valuation analyst know what amount of revenue the business will generate five or ten years from now?
  • How does the valuation analyst know what expenses the business will incur in the future?
  • Why are future cash flows being discounted to present value at a rate of 15% or 20%?
  • Why is there a discount for lack of marketability and how was it calculated?

While these are just a few business valuation inputs that may seem obscure and there are certainly others.  Once the curtain is pulled back, however, there really are no secrets.  Every input that goes into a business valuation must be logical and supportable.  These inputs are often scrutinized by the statutory and regulatory authorities, auditors, or opposing parties in litigation, making it important for the valuation analyst to carry out a thorough analysis and support all of his inputs.  Unfortunately for entertainment purposes, there is no real magic in a business valuation.

What Are the Sources of Differing Value Opinions?


Among the dozens of potential sources for different value conclusions, the following are among the most common or important (and will be addressed in future blogs)

  • Type and degree of “normalization adjustments” (calculation of earnings/cash flow amount)
  • Weighting of different valuation methods/results (income/market/asset approach methods)
  • Application of discounts for lack of control or lack of marketability (shades of control/marketability)
  • Interpretation of future events/financial results
  • Differing derivation of discount rate/cap rate and multiples (risk assessment)
  • Depth and breadth of available/provided information
  • Nature of “interest” being valued (assets or equity)
  • Purpose of valuation (affects standard of value, premise of value, effective date, etc.)
  • Legal or governmental issues

It is the manner in which these different issues or procedures are addressed which comprises the “professional judgment” that underlies the valuation opinion.  It is not too difficult to imagine how even subtle differences across multiple assumptions can culminate in a sizable “difference of opinion”. In this light, modern business valuation is similar to democracy. It has many shortcomings and is far from perfect, but it is the best available option for handling the challenges of modern business life.

The truth is that valuing a business isn’t always a simple or straightforward process. There is also a range of reasonable outcomes: there is no one single number that will ever be 100% precise. By definition, the value of business is determined by a proper assessment of the relationship between the future returns generated on an investment and the risk of attaining those returns. That’s why you can’t just simply plug some numbers into a spreadsheet and come up with an accurate answer. You need to assess the risks it faces as well as where the company is going compared to the rest of its industry.

Is Valuation an Art or a Science?

This is an age old question pondered by valuation experts many times over. Most valuers tend to err on the side of valuation being an art rather than a science, mainly on the basis that it requires judgment and is a statement of opinion not fact. However, I believe it is reasonable to disagree with the proposition that valuation is an art not a science to some extent, i.e. one could argue that it is probably a mixture of the two.The fact that one follows a logical process in reaching a valuation opinion means that there are, it can be argued, scientific elements to it. For example, a rental valuation of an industrial building involves carrying out relevant research such as finding out rental comparables and yields acceptable for similar buildings. This objective evidence is then used to formulate and support the valuer’s opinion.


The art lies in the subjective judgement(s) that a valuer makes, having considered the research/evidence carried out, in actually putting a figure against an asset and in making appropriate adjustments, e.g. for differences between assets. However, the interim process of gathering evidence and making calculations, it can be said is more scientific than artful, in that it is methodical and planned, rather than spontaneous and creative. Certain types of valuation are more scientific than others, e.g. insurance valuations are more a case of calculating costs and making calculations, and there is less valuation ‘judgement’ involved than with, for example, market valuations. A good valuation is 75% art and 25% science because it takes into account the story behind the numbers of a business. Appraisals fall down when there isn’t enough support for the story behind it. It’s based not on just what happened, but on why things happened. But remember valuation may be considered as an Art – But that Doesn’t Mean it’s Always Pretty.

From a ‘purist’ perspective, some would argue that valuation is neither science nor art; it is its own subject entirely. However, from a general perspective, it may be argued that there are scientific elements to all art (e.g. music can be quantified and measured and transposed into written form), and therefore science and art can, and often are, interrelated. One could surmise that science and art are both ‘human’ concepts; one being the concept of reason and the other being the concept of creativity. If   has to be placed into one of those two brackets (reason or creativity), then most laymen might opt for reason because it is a subject which follows logical procedures  and employs specific calculations.

There is not an exact formula or method to arriving at a valuation figure. Analysts have many tools at their disposal, which give way to wide ranges of opinion. There is cash flow, net asset value, earnings, total enterprise value, revenue and book value, to name just a few of the popular metrics. A multiple is then applied to one of these figures to arrive at level of valuation. The multiple is where valuation becomes an art. There is no tried-and-true figure to apply to a company, which opens valuation up to much debate. Depending on the multiple, a company can be either overvalued or undervalued

Valuation is a craft

“Price is what you pay, value is what you get,” a famous Warren Buffett quote, is certainly most applicable to business valuation.Unlike physics and mathematics, indisputably sciences with immutable laws, valuation has principles but none that meet the precision threshold of a science.At the other extreme, valuation is not an art, where your creative instincts can guide you to wherever you want to go and geniuses can make up their own learn what works in valuation—and what does not work—by doing it. Every valuation has a story, it’s  less about the numbers than we think. The art of valuation comes from the valuation professional’s need to apply his or her own judgments, estimations and decisions to reach a conclusion for the value of a business. Valuation is commonly considered to be a statement of opinion rather than a mathematically proven fact. A craft is a skill that you learn by doing. The more you do it, the better you get at it.Valuation is truly a craft that considers a broad range of quantitative and qualitative factors in the process of search for a true value.

A peek behind the curtain

“The value of an idea lies in the using of it.” Thomas Edison’s words could be rephrased for business valuations. The valuer arrives at the value which is defensible, fair, and accurate to the extent possible, by artfully using the basics of scientific valuation models to craft a magical valuation number using a complex tool mix of interpretation, calculation, estimation, judgment, opinion, guess and   hunch.


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