12. Valuation of companies

Chapter 12



by: josavere


If the accounting constituted a good measurement of the enterprise activity, actually we would not have to speak of this subject. Simply we would take the value from the patrimony or differentiate between assets and liabilities in agreement with the fundamental equation from that technique.

But it is that this discipline has advanced very little with relation to the world of the businesses, and without violating the countable principles, it can be fallen into great imprecision unless sufficient complementary information is had.

Two exactly equal companies (if there were them), or the same company, could present/display different financial statements from the same exercise. Everything depends on the methods of the estimate, amortization, and the other procedures in general, that practice.

For that reason for decisions of great spread one needs very occasionally, to estimate a company, in special in the following cases:

a. In order to see if it is eliminated or it is reorganized in case of a crisis.

b. If any of the partners decide to possibly sell its participation.

c. To study a possible fusion.

d. To sell it like integral a legal being.

e. To make a partial sale.

f. To make an operation of a trust.

g. To contract insurance.

h. To project a work of reengineering.

i. In vain of its owners.

It is most important to clarify a concept derived from the continuity principle, according to which an organization has indefinite life unless specifically, the opposite stipulates itself. The value of the company in operation is completely different from that of closed. When the public knows that the company has let work returns obstinate to pay the accounts that must immediately and sub valorizes everything that has to do with her. The single decision of closing reduces in the highest proportion the value of the business.

Most serious it happens with the intangible assets which in certain such tangible cases have more value than and can constitute the departure point of a possible negotiation of rescue or recovery of the investments in publicity, Commercial technology, Know-How, Good Will, Premiums, etc.

The more useful financial tool in the estimate of companies is the flow of funds, which must have its SUFFICIENTLY SOLID SUPPORT. For it agrees to review the data of the past and in the case of a disproportioned increase it must have some reason makes specific that in fact, it can be viable, as it would be the case of additional investment, a special plan of qualification for all the personnel, a technological development, etc.

If the variation is normal it will be a question to review that the conditions stay that has served as a base. In the event of which that flow is reduced (so rare case that it requires a very special justification) equal we must make the verification corresponding. Once we are very safe in the flow of bottoms, we come to its discount using the rate more adapted in agreement with the following criteria to choose one: 

A. MARKET RATE: the interest rates fluctuate particularly with more or less ample regularities depending on the economic cycles and in Colombia because the market of capital and money is very imperfect and is dominated by a few people. By the others, in the country, many gestures exist that increase in price the money, a factor that is due to consider.

B. COST OF CAPITAL: let us remember that the capital cost is defined as the weighted average of the different sources from financing and that is a money changer because efficient financial handling implies agreed-on structural variations with the circumstances of macroeconomic type. 

C. RATE OF COURT: before the analyzed disadvantages it is left as the rate of a cut alternative that represents the minimum yield waited for by the investor at issue. She is one who appraises subjectively fixed like an enterprise policy and that, of course, must pay attention with base in objective criteria as they are it the yields in the financial market (free rate of risk) and the risk that the investment in individual implies. We do not forget that in the measurement of risk very little one has advanced in financial theory. Nevertheless, for the particular case that one appears, we will use the statistical measures of dispersion (rank, quartiles, variances, betas, etc.)

In any case, the risk is required of maintaining presence much more which imply the decisions of the enterprise world when is to valorize the company as a whole. The businesses can be good at a certain time and for being damaged by a wit how by the management; also the opposite case can happen.

Possibly, situations can be presented/displayed in which the reason for the decision affects positively or negatively the value of the company/signature. For the executives and the specialized technical personnel, the change of owners can be an abandonment cause and by this one single fact, it is probable that the company loses a high proportion of its total value. In other cases the opposite in regard to a new mentality, new technology can happen, etc. 


For the effect, we make two classifications basic: one for the companies in March and another one for the companies in liquidation. In this case, in general, the different methods point more to the sub estimate, due to the implicit failure although in certain cases the guessed right decision more can be the closing of the business, in which case we would not be speaking of estimate properly, but of a value of liquidation in an ordered process.

For the companies in March, on the contrary, especially the intangible assets, the hidden reserves, and the expectations of the business increase the value, when the value is being generated. 


A. VALUE IN STOCK MARKET: if we spoke of a joint-stock company a good system of estimate would be the price in the stock market of the action multiplied by the number of actions in circulation. The previous thing is not more than a theoretical assumption but a base not to consider the value of a company.

The stock markets in Colombia are very little representative because the market is far from which it would have to be: Perfect. Very counted people with the economic capacity and privileged information will handle the prices of the actions according to their conveniences with the calls crossed operations.

In addition, in the event of which some try to buy a company by this procedure, the maintained demand increases the price of the actions, until levels that flew over them, a phenomenon that appears when there is one bid up by a position in the Board of directors. 

B. VALUE OF I REPLACE: the technical principle consists of considering the number of monetary units that will be needed to replace the organization by some special circumstance.

The calculation is done taking the assets and applying to each one of them the suitable criterion of the estimate, and coming similarly in the liabilities. The method is recommended for the event to contract insurance. It must consider the value of the dismissed profit that can be presented/displayed considering the capacity of the generation of cash. 

C. MULTIPLE OF PROFITS: it consists of calculating the excesses of the last year and considering the value like the product of this number by a number of times. It is a method used enough in commercial businesses. He is very arbitrary, but in those terms, the retailers are understood very well. 

D. COMPARABLE TRANSACTIONS: this if it is an arbitrary affluent method. Who says that so comparable is a business with another one; who guarantees the precision degree using in the business that serves as a base? By means of this method, the purchase of a group of small companies or commercial establishments could be manipulated "fixing" the first purchase.
More arbitrary it is even the procedure when transactions of different countries are compared and in "apparently equal" conditions. This modality is lent so that that it dominates the sector increases more and plus its patrimony to expenses of smallest. 

E.  DISCOUNTED PROFITS FLOW: The projection from profits of the company/signature in certain periods is taken and they are engaged into a net present value.

P: value to calculate
U: projected utilities
K: rate of discount
n: period of time

It presents/displays the own imperfections of the calculation of the utility in agreement with the countable technique, which comments in documents on the countable principles and the financial analysis. He would be applicable for companies with operations of strict counted and very amount of certainty in the form to calculate the utilities. 

F.  DISCOUNTED CASH FLOW: a projection becomes of the cash flow by a certain period and it discounts or it is engaged into a net present value.

P: value to calculate
Ft: projected net flow
K: rate of discount
n: period of time

It is the own method of the analyzed ones until the moment. It obeys the noticeable tendency of the finances to use the flows of money like an estimating system. 

G. VALUE OF THE DISCOUNTED DIVIDENDS MORE SALE PRICES PROJECTED FOR THE SHARE OR THE CONTRIBUTIONS: the dividends waited for to present value are engaged in, and to this result the waited for entrance of sale of the share in a certain period is added to him (equal to the period of the budgeted dividends). Also discounted and brought to present value.
The total value calculated by this procedure constitutes the price of an action or a contribution. Multiplied by the previous value by the number of actions or contributions we calculated the value of the company.

V = PV * quantity of shares

P: value to calculate
dn: projected dividends
Pvn: sale price projected for period n
K: rate of discount
n: period of time



He is identical to the previous one but calculating solely the residual part or what corresponds to the shareholders. We know that in the income of money of a company to the government and the creditors participate.

These games calculate for every period and they reduce the net income. This net flow is engaged in to present value like in both previous cases. They have the immense advantage to directly calculate the value for the owners and the disadvantages that we have mentioned previously for the methods of discount; it has had a great welcome with the practical field. Also, he is unacceptable for companies in no liquidity situation.


The present value of the operative flow calculates; one adds the residual value and the value to him of the no operative assets, that is to say, that can be eliminated without affecting the operational capacity of the company; the value of the debt is reduced to him.
The discussion of the method is centered on the period to take to discount the operative flow, the rate to use and the form to calculate the residual value. The estimate criterion is due to remember very, for the no operative assets. This method widely is recommended by Dr. Fernando Gutiérrez Marulanda (q.e.p.d) in its book EASY MANAGEMENT.

V = Vpfo + Vr + Al + Dt

V: value of the company
Vpfo: present value of the operative flows
Vr: residual value
Al: active no operative liquefiable without affecting the operational capacity of the company
Dt: total debt



In the estimate of companies we took the traditional tools from the financial mathematics, that is to say:

A. TIR: it is the rate that is equaled to the initial investment (value of the purchase) with the future income that the company generates. The resulting number is compared with the rate of cut; if he is superior, the project is profitable.

i vs TC

i: the rate that equals the cash flows
TC: Rate of court
An Projected future income
n: Period

It has the very serious disadvantage of assuming reinvestment of the future income of the same rate, the thing that very hardly can be given actually, in maintained form.

B. NET PRESENT VALUE: the future flows of bottoms discount to the rate of cut. If the flow is greater than the zero investment is advisable, as much better how great it is the number.

C. PERIOD OF DISCOUNT: in an arbitrary form, the financial theory accepted five (5) years as a period of the appropriate time to make the estimate of a company. The author differs openly from that concept when she is used in a generalized form.

In the long term trade and finances, they are parallel. If a company obtains a positioning in the market, except for badly a handling or a very special situation of macroeconomic type, it has properly assured its finances in the long term.
Being companies sufficiently positioned, calmly the period of discount to the criterion of the evaluators can be extended. The opposite case also can occur. 

D. RESIDUAL VALUE: it is another topic of particular importance in the valuation of companies. In theory, once established a cash flow and assumed the indefinite life of the company, he would be equal to the annual cash flow divided by the rate of cut.

Vr: value to calculate
Fn: stabilized flow
Tc: rate of cut

The previous processing implies, in any case, the reinvestment necessary to have a flow stabilized through time (infinite series). We faced then, a phenomenon difficult to consider in numerical terms like exogenous variables, technological developments, new inventions, customer changes, habits, way to live, governmental policies, which can be determined in the duration of a company.

This residual value also has to do with the policy that the company follows as far as modernization of equipment, publicity, investigation and development, maintenance, and mainly with relation to the personnel, most valuable and little weighed enterprise resource. Let us remember that never could be reached the total quality in the enterprise scope if the human element (specifically the high executives) does not have it.

The diagnosis on the human resource weighs frequently on the residual value. Unfortunately, accounting has very little or nothing to contribute to this matter. Exceptionally the sports clubs, without much technique, appraise in a value to their sportsmen like part of the assets.

Especially consideration for effects of the residual value must take control of the price of the lands which constitute an authentic currency lasts and safe in very particular cases they are valorized in greater proportion to the rates of inflation. 


A. VALUE IN BOOKS: in the initial presentation somehow already we mentioned this method. In Colombia particularly it constitutes badly a procedure because hardly in 1992 we began to make adjustments by inflation (With a quite imperfect system) and because traditionally the accounting has been oriented with a tax criterion looking for to reduce the payment of taxes. In addition, as I am mentioned initially, the accounting by lack of development is not able to measure the rate of the businesses.

B. VALUE FIT IN BOOKS: this method leaves from the base of the previous imperfections and tries to make the corrections of the case. In this sense, it represents a great advance and in fact, it can be a good tool in determining occasions, especially when the company this closed by some special condition or is of the administrative or legal type. 

C. VALUE DE MERCADO: of course it constitutes a given resource in a while, especially when a closing has been ordered. It has the very serious disadvantage, that the goods lose much value, when it is a liquidation, in addition to the danger that carries the morality of the ones in charge of the execution, especially in case of people other peoples to the organization, to those who it interests the own benefit much more to them, also is due to consider the generalized corruption. 

D. VALUE OF DECOMPOSITION: in the concept of the author it is a suitable method more for these cases. It consists of the individual analysis of each one of the assets of the company and applying a suitable concept to them of the estimate to each one in individual. The total value will be the summa of the total assets including the intangible ones, except the total of liabilities, brought to present value. 

5. METHOD OF josavere

To the way of conclusion, we will analyze the method of everything of the author.

Considering the particular situations of type MACROECONOMICS, conditions of the salesman and the buyer, the possible effects of SINERGIA (A + B < A U B), the particular knowledge and vocations, the effects on different publics that it handles the company in question (a company in a community of people); and in general a great amount of analysis of QUALITATIVE type we can come near to define the value of a company.

The calculated values mathematic, using different technical presented/displayed in this document, used inappropriate form, constitute the parameters of valuation. The analysts must initially define the major combination appropriate for the case and with base in them of calculating values that serve as parameters to come to fix the VALUE FINAL, the result of negotiation between the parts. Let us remember a fundamental premise: only that it gives him value to assets or company in general, from the financial point of view, is its capacity to generate cash.

The countable results have very little influence on the finances. It is recommended special attention in the diagnostic of the human resource and its receptivity to the decision that is going away to take, under the frame of the potentiality to generate value-using projections of the .

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