The different methods of company evaluation - Free Essay Example

  Critically review the different methods of company evaluation Valuation tools including Share Value Analysis (SVA) and the value drivers of SVA and how they are seen to drive the value of a company. In order to critically review the different types of methods of company evaluation, one must understand the meaning of company evaluation and to understand what valuation tools are available to use for example Share Value Analysis (SVA), the drivers of Share Value Analysis and how they are seen to drive the company. In order to investigate information which is needed for evaluating companies there are certain factors which need to be considered, factors which affect the value of the company and the sources of information which are needed. There are specific analysis which must be performed before a company evaluation can be determined, these are business strategy analysis, accounting analysis, financial analysis and a prospective analysis. A business strategy analysis is the ability to evaluate the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s present financial position and the likely performance in the future. There is the need to identify the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s position in relation to its competitors, investigate the key successes and any potential risks that will affect the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s business performance and to be able to identify how well the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s successes and risks are being managed. An accounting analysis is the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s accounting methods which can ultimately expose or obscure the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s business strategy and economics. In order for the company to do this is must judge how effectively the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s financial statements can reflect the business, and the ability to learn how to adjust any financial statements as needed. A financial analysis is the ability to evaluate the effectiveness of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s strategy, and to be able to make sound fi nancial forecasts by examining all the cash flow measures and ratios of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s operating, financing and investment performance. The prospective analysis is the knowledge of how the company is performing and how it will perform in future markets which is the key to business decisions. A company evaluation is the process and procedures used to approximation the economic value of the company. A valuation of the company is used to determine the price by which they are willing to either pay or to receive to complete the sale of a business. Documents which are usually required to determine the company evaluation are the accounting documents à ¢Ã¢â€š ¬Ã¢â‚¬Å" income statements, balance sheets, cash flows and annual reports etc. Depending on what kind of requirements are needed, there are several methods which can be used, discounted cash flow, net assets, peer comparison and the estimated liquidation value. The company valuation process starts with a thorough de finition of the company in questions activity, i.e. where sales have been achieved, the different criteria a competitor/ potential buyer will take into consideration during the valuation process. There are, of course, several factors which come to the forefront when looking at the accuracy of these figures and of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s past activity. These questions include are the figures are realisable to give the company a true evaluation. There has been a move away from accounting practices as company evaluations become more independent. There is a difference between the accounting approach and the marketing approach in that the accounting approach of company evaluation in that it is past orientated and the value is high earnings related. There are other factors which need to be considered aside from the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s earnings related monetary value. There is also the need to take into account several factors such as insufficient profit indicators, res earch and development expenditures, goodwill that the company has acquired. There is also the legitimisation of the accounting statements in regards to what is actually to the stakeholders, management and investors, that there may be different versions depending on the stake that it held in the company. There are several methods of company evaluation available, due to different accounting systems applying different categories. One of the most popular methods of evaluation is discounted cash flow, which according to discounted cash flow the value is the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s total earnings in cash that a company realises in its business activity during the long term operation. The company value is then the discounted value of the expected future cash flow. There are disadvantages of this system it can only be successfully applied when the company is operating in a stable economic environment and if it is in the adulthood of its life cycle as in the introduction phase it has n o real forecasting basis. As in the first year of operation, most companies make losses rather than gains. In a stable environment, cash flow can be forecasted almost exactly. If however the company is situated within a dynamic environment it is impossible to use this method of discounted cash flow as it is near impossible to determine any potential revenue or cash flow. Valuation with multiplication indicators is based on the comparison of company indicators. Price/ Earnings (P/E), Price/ Sales (P/S), P/EBIT, P/EBITDA are the most widely used indicators. These indicators are easy to get access to if the company is listed on the Stock Exchange, but if the company is not listed, average indicators of listed companies from the same sectors are taken into account. Again there are disadvantages to this system, this method can be applied on a developed capital market where the average indicators of a lot of companies have been identified for some time and can be used as multipliers. T he multiplication evaluation cannot be used if the company starts its operation on a completely new business model and if there are no other companies with a similar profit structure on the market. Economic Value Added (EVA) is the net operating profit less adjusted taxes. The main advantage of Economic Value Added is it takes into relation the opportunity of the costs of capital. This method is when a certain amount of capital is invested with a particular aim to the investment, the returns are lost which could have been realised and they could have been invested in something else. The conditions of profitability are not meet by the revenues which exceed the expenditures. The most important factor in this method is the cost of the invested capital has to meet the return objectives and these are not taken into account. The Economic Value Added method has become one of the main methods in monitoring the birth of Shareholder value. The Economic Value Added is the measure of the val ue a company has created for itself over a period of time and is very closely linked with Discounted Cash Flows. The disadvantages to this method, like discounted cash flows, is in the accounting. Share/ Shareholder Value Analysis (SVA) is the full revenue to shareholders in both dividends and share price growth, calculated as the present value of future cash flows of the business, discounted at the cost of capital of the business less the market value of its debt. Shareholder value theory is setting an objective which can be achieved through the interests of other stakeholders, there is the need to ensure the long term satisfaction of creditors, suppliers, consumers and employees. In the centralisation of this theory lies the interests collectively of all stakeholders. There is only one condition that the stakeholders are satisfied and with this the main goal of the company is to reach the stakeholders goals. Company value can be increased only if the interests of the sharehold ers and stakeholders are taken into account. The new standard in company evaluation is Shareholder Value Analysis (SVA) due to the increasing realisation of the defects of conventional accounting. Accounting practices give confidence to a short term view of the business and company evaluation. It also encourages under investment and accounting practice only seems to concentrate on tangible assets. Shareholder Value Analysis can avoid this bias performed by the accounting practice but to achieve the Shareholder Value Analysis potential there needs to be some sort of marketing in order for it to make a viable contribution to the company strategy. The principle behind Shareholder Value Analysis is that the company/ business should be run in such a way that it maximises the return on the shareholders investments. It is a tool used for calculating the Shareholder Value Analysis from any given investment, profit and growth projections which have been made. As Shareholder Value Analy sis does not tell managers how to work out strategies, and that is why a marketing strategy is needed. The main purpose behind Shareholder Value Analysis is that the economic value is created only when the company earns a return on investment which exceeds the cost of capital. Without any kind of unique advantage , the competition will end up driving the cost of capital down, so creating a Shareholder Value Analysis is about building a sustainable competitive advantage. . Whereas marketing provides the tools and encourages Shareholder Value Analysis to be growth orientated and dynamic rather than how it would not exist without a marketing strategy except as a static tool which focuses on ways to reduce costs and assets. Within the marketing strategy, Shareholder Evaluation only provides answers for evaluating company options and decision making options. Shareholder Value Analysis is used to calculate the total value of a strategy by discounting cash flows. With discounting it ref lects that there is a time value on money and because money can earn interest then the same amount received last year is worth more in the future. It is self interest which increasingly puts pressure on the company to maximise their shareholder value. There are financial value drivers associated with Shareholder Value Analysis and the marketing process is seen to influence these. Firstly, the anticipated level of operating cash flow à ¢Ã¢â€š ¬Ã¢â‚¬Å" the greater future free cash flow anticipated the greater the return for the shareholders. Second, the anticipated timing of cash flow à ¢Ã¢â€š ¬Ã¢â‚¬Å" cash received today has more worth than cash received tomorrow so the cash flow is penetrated into the market earlier to positively generate more value. Thirdly, the anticipated sustainability of the cash flow à ¢Ã¢â€š ¬Ã¢â‚¬Å" the more lasting the cash flow, the greater the value which is created. And finally, the anticipated riskiness of future cash flow à ¢Ã¢â€š ¬Ã¢â‚¬Å" the g reater the perceived volatility and vulnerability of the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s cash flow, the higher the cost of capital is to be used to discount the return for the shareholders. When it has been justified that a company value has been determined, there are several factors which should be taken into account besides the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s revenue creating ability. Apart from current company investments for creating values, there are factors such as expected potential investments, cash flow and other opportunities for growth. A companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s valuation can also be due to its possession of assets which can sooner or later produce free cash flow but also so that in the future it will be able to obtain them. There are various differences between market value and book value. To obtain assets recorded in the balance sheet may cost more than their book value. Assets should be sold independently and should not be shown in the accounting statements as they repr esent value for the company i.e. its own name or brand e.g. Coca Cola etc. The synergy effects of resource combinations adds value to the company à ¢Ã¢â€š ¬Ã¢â‚¬Å" the employees etc and they are not a separate entity in the balance sheet or accounting statements. The company should be able to make use of the creative value of the functional areas e.g. trademarks, brand names, patents and business secrets. There are also the market forces to consider i.e. the size of the market, market share, market growth etc. Other factors which need to be considered are life cycle, driving forces, core competences, restrictions on entering the market etc. The features of the country the company is in is another big factor and a company should perform a PEST(LE) to assess the political stability, regional position, technological development within the country, economic situation of the country, and cultural development among others. There human resource organisation is also of importance to the company evaluation e.g. cultural motivation, intellectual capital, creativity of the company, business relationships, goodwill etc. The workforce and organisation is full of contradictions in that there are labour related costs but also this labour can influence performance. Employees are knowledge and help with the running of the business through this knowledge and abilities in return for motivation, financial security from the company. With motivation and satisfaction comes loyalty and commitment from the employee. Loyalty creates value, this includes loyalty from the employee, customers and partners as well as the companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s investors which can equal higher productivity, cost advantage and profit and growth. Business relationships are also important in creating value. Social and economic dimensions play a part in this. The evaluation of these business relationships depends on if the relationship is described as important or less important, and in certain bu siness sectors there is an emphasis on personal relationships because of competition in personal relationships as well. Performance evaluation is also an important factor as this provides important information for the company evaluation. The analysis framework for the performance evaluation is, orientation which is controlling, reporting and feedback, the second is balance which is the content and information available, and thirdly, consistency which is the strategic links as well as the harmony between application and importance. Performance measurements should provide the company with information supporting the decision making process and to ensure feedback. It is also important to understand what kind of information the company collects and on what. The source of the information and its character are important factors. In order to critically review the different methods of company evaluation, a number of issues needed to be investigated. What is company evaluation and how i s it perceived. Another question which was examined is the valuation tools involved in a company evaluation. These included a number of factors à ¢Ã¢â€š ¬Ã¢â‚¬Å" discounted cash flows, Economic Value Added (EVA) and valuation with multiplication indicators. From this came Share/ Shareholder Value Analysis (SVA), their drivers and how they are seen to drive the value of a company. These are all very important factors when evaluating a companyà ¢Ã¢â€š ¬Ã¢â€ž ¢s worth and to how that evaluation is perceived through a number of factors produced both by internal and external factors. Bibliography Doyle, P., (2000) Value-Based Marketing: Marketing Strategies for Corporate growth and Shareholder Value, Wiley, New York Thierauf, R.J., (1980) Management Auditing: A Questioning Approach, AMACOM, New York 1