• Valuation of a Firm – Culinary Arts Series 1

    • January 1, 2020
    • Posted By : NichefinConsulting Admin
    • Comments Off on Valuation of a Firm – Culinary Arts Series 1

    Valuation models are like culinary dishes well decorated and served to the investors with an intent to arouse their appetite and senses and convince them to invest in the firms. Preparing such a dish requires a lot of effort and is definitely an art. Even though the acceptability of its taste depends upon the perceptions of the investors but if the dish is prepared well with proper well thought out ingredients it will definitely have happy customers.

    Well, if we talk about start-ups or seed-stage companies the valuation methods adopted may be different but the basic inputs/ingredients remain the same. The question is how to make sure that the right inputs are selected and valuations are properly done. Which ingredients to use? How to procure or make those ingredients? In this article, the foremost important input for valuations i.e. growth assumption is discussed. The rest of the ingredients will be discussed in the upcoming write-ups.

    The growth rate is the most critical of all the inputs used for valuations. Growth assumptions can be drawn from past financial statements by looking at the trends of past sales and earnings. While historical growth rates can be stale- may not be a reliable source to predict future growth rates but it does provide a base rate that can be valuable while making estimates for the future. Other ways to estimate the futuristic growth rates are to scan the industry and macroeconomic reports in addition to doing strategic analysis ( SWOT, PESTLE, Five Forces, etc), competitor analysis and financial analysis of the company. The focus should be on the future operating and earning capacity.

    Growth can also be obtained by doing fundamental analysis. We can analyze the trend of investment in assets and see how aggressively the company is expanding its asset base. An increase in investment in fixed assets is a good indicator of the growth plans of the firms. Another important growth indicator is the amount of reinvestment which when multiplied by ROE gives an internal growth rate.

    A high growth business can use increasing growth rates over the valuation horizon period however, a conservative sustainable industry or economic growth should be considered for the perpetual value calculations in case of going concerns. A little extra pinch of growth estimate can improve the taste of profits and returns as the large chunk of valuation depends upon the terminal value and a small increase in the assumption of growth rate for the terminal value calculations can fully swing the valuations. The chefs can apply their skills to twist this figure a bit to prepare favorable valuations – more ” Tasty” and appealing for its users. The question here arises whether that extra pinch of ingredient is good for long term health and sustainability.