Nowadays, the valuation professionals have been pushing much more stress on the current Covid-19 environment on to the discounted cash flow (DCF) method i.e. the income approach as applicable to the valuation of the entity under consideration.
Guide to Business Valuation
- As we know that all businesses have not been negatively impacted by Covid-19 so we need to consider the specific fundamental facts along with the conditions of the business impacting its financial and operational outlook in its valuation analysis.
- Apparently the economic downturn along with its recovery are highly uncertain and the extent of the recession triggered as a result of Covid-19, and the ultimate recovery, upset the prospects for its growth and the profitability at the industrial and individual company level.
- Nowadays the DCF method has turn out to be the suitable method for business valuators in the new post covid-19 environment as the DCF method requires significant judgement by the valuation specialist based on the management perspectives with regard to the company\’s long-term outlook.
- As the risks and uncertainty of the businesses considerably increased impacting the risk profile of the concerned company under business valuation. Thus, the higher discount rates adversely impact business value of the entity.
- Moreover, the weighted average cost of capital (\”WACC\”) appears to be on higher end as the WACC denotes the \”discount rate\” converts the prospective cash flow at the invested capital level to derive the net present value. Contributory are the underlying market-derived WACC inputs that have risen i.e. alpha factors, liquidity premiums reflecting the greater risks & uncertainty impacting the company operations and financial stability.
- It is of great importance that the risk and uncertainty must conform with the company\’s operational outlook for its financial projections to be used in the business valuation. If the cash flow of the company has been adjusted to completely reflect the covid-19 related impacts over the period under consideration, then the assortment of a discount rate must be established to match the forecast risk.
- Forward-looking public companies market multiples are underscored as the recent financial history of a company under valuation (its past revenue, earnings, cash flows) are now regarded as less reliable parameters as they do not reflect the post covid-19 company\’s financial circumstances and earning sustainability appropriately.
- Market transactions of non-publicly-traded companies are no longer useful for the business valuation under the guideline transaction company method (\”GTCM\”) as they are now less reliable because the market multiples are now dated and reflect the price levels of pre-Covid-19 earnings and outlook factors.
- In addition, the cost (or asset) approach has been taken on more significantly as businesses have become financially distressed, and the company worth more based on the value of its net asset value rather than as a going concern.
- Currently the higher discounts for lack of marketability as the transactions of businesses have phenomenally decreased as a result of the slow market activity and decline in interested willing buyers causing the decrease liquidity.
Overall, the Covid-19 circumstances have move on to the fundamental approach to the business valuation forcing the valuation professionals to reassess their valuation methodologies and approach. Rigorous asset impairment testing will be the new reality as the businesses have experienced noteworthy structural changes to their operating models ensuing in financial instability giving rise to the asset impairment charges. Moreover, the businesses may fail and/or be forced to restructure and reorganize. In these occasions, businesses and their underlying assets may also require independent fair valuations.