Business Valuation & Financial Management: A Comprehensive Guide

Posted on Oct 11, 2024 in Economy

Calculation of Working Capital

For a given set of policies in areas of procurement, production, sales, and financing of providers, there will exist a minimum working capital that can serve as a reference for calculating funding requirements and controlling established policies.

Fixed Assets (Positive):

  • Detention in cash.
  • Immobilization of raw materials (raw materials annual consumption x D1).
  • Freezing in the production process (annual production cost x D2).
  • Immobilization of finished products (annual sales at cost x D3).
  • Immobilization on behalf of clients (annual sales x D4).

Fixed Assets (Negative):

  • Immobilization of suppliers (purchase of raw materials on credit x D5). All this divided by 365.

Working capital (FM) = Positive Immobilization – Negative Immobilization.
FM = AC – DC.
FM = DF – AF.

Methods for Determining the Overall Value of the Business

German or Indirect Method:

The value of performance is theoretically correct, but its calculation is fraught with uncertainty and must be viewed with reservations. The uncertainty adds to the substantial value the average enterprise goodwill.

Anglo-Saxon or Direct Method:

It estimates the value substantially in a known way, then calculates the performance that could produce an equivalent capital compared to the benefits obtained. This way, we get the company’s super benefit, giving rise to the existence of goodwill.

Basic Principles of Valuation of the Company

  • Principle of Objectivity: The value of the company must meet objective criteria.
  • Start of the Season: The value of the company must refer to the time when it is calculated.
  • Principle of Prudence: The value of the company should be determined prudently.
  • Principle of Specialization of the Exercise: Each exercise must impute income and expenditure.
  • Principle of Permanence on the Endpoint: The endpoint is to be maintained throughout the unit period.
  • Principle of Valuation: The value of the company should be unique.
  • Principle of Anticipation of the Future: To determine the value of the company, we must not only take into account the economic reality of the company but also future profit expectations.

Miller-Orr Model

The authors analyze how companies should manage their cash balances when they do not know with certainty when the inputs and outputs will occur. While the cash balance fluctuates between two limits, the transmission of cash will act when the balance does not touch one of the limits. But if the manager has to come to act, they must buy securities if the balance is at the lower limit (LI) and sell securities if it is at the upper limit (SL). Three cases justify the separation limits: daily variation of the flow of fixed stocks, the cost of buying or selling securities, and the interest rate.

Leasing

A lease with an option to buy, where we pay a monthly fee to enjoy a movable or immovable asset owned by the leasing company. Three subjects are involved:

  • The Leasing Entity: Bank, savings bank, receives the lease payments.
  • Tenant: The person who signs the contract and enjoys the asset during the contract period.
  • Provider: The person who will deliver the asset subject to the leasing contract.

The leasing company acquires the asset under contract and simultaneously gives it to the lessee for a time and upon payment of the monthly fees.

Types of Leasing:

  • Furniture Leasing: Aims at movable assets.
  • Real-estate Leasing: Aims at immovable assets.
  • Leasing of Goods and Finance: The leasing company is committed to delivering a good but not its maintenance or repair, with the user being required to pay the fees during the term of the contract.
  • Operating Leasing: Lease of a movable asset, where the landlord guarantees the proper functioning of the property.

Renting

A commercial contract whereby the landlord grants the use of the property to the tenant, who agrees to pay an amount for a determined duration. The landlord undertakes the maintenance of the asset.

Characteristics of Renting:

  • Rent is made short to medium-term.
  • The maintenance of the property is done or provided by the landlord.
  • The purchase of the property is optional and can be arranged between the parties.

Advantages of Renting:

  • Lower asset costs for the company.
  • Improvement of the company’s balance sheet by not increasing indebtedness.
  • Payment is considered tax-deductible.
  • Does not diminish the company’s liquidity.
  • It is possible to change a property in the event of failure.

Disadvantages of Renting:

  • Can only be performed on certain properties.
  • Ownership of the property is not acquired.
  • There is an early termination penalty.
  • Repairs are made in workshops designated by the renting company.

Baumol Model for Cash Management Demand

The cash receipts are produced at an instant of time and disbursed regularly. The Baumol model assumes an environment of certainty, meaning we know quite accurately the income and payments that occur in each period. Fees and relevant costs for determining the optimal cash balance are:

  • Opportunity cost of having a cash balance (what we fail to win by not investing those resources).
  • The cost of transforming a balance of each investment into securities or options and vice versa.

R = liquid resources left by the company to meet payments of the first period.
I = amount invested.
C = amount of divestments in each period or liquid in each period.
We will take into account R monetary units, invest I in units of currency values, and become I/C times per period, with C monetary units from investment securities into cash.

Assessment of the Company

Mathematical or Accounting Value of the Company:

Also called arithmetic value. It is determined by the difference between real assets and liabilities of the balance sheet.

Settlement Value of the Company:

It implies the extinction of the company. The liquidation value is obtained by adding the value of selling the assets and subtracting debts and liquidation expenses.

Replacement Value or Reconstitution of the Company:

Determined by what it would cost to acquire an operating business with the same production capacity and performance, generating benefits equal to the company being valued.

Substantial Value of the Company:

Determined by the discounted value of all goods and rights that the company has, less the value of debts.

Stock Value of the Company:

The product is determined by two variables: the value of the shares and the number of existing shares in the market.

Yield Value of the Company:

It is equal to the discounted value of all expected benefits.

Goodwill

The value of the company is determined by two parameters:

  • Material value or substantial value of the company.
  • Intangible value of the firm or goodwill.

The intangible value depends on the organization, brand, and patents. These aspects determine the performance of the company and exceed the performance of the sector to determine the merits of commerce. There are two criteria to determine goodwill:

Indirect:

Arises from the difference between the value of company performance and the substantial value.

Direct:

Computes the normal performance attributable to the company. It is compared with the benefit that the company gets. This difference determines the bottom of commerce.
r = performance that the business gets.
k = normal return of the sector.
Given that goodwill is relative, it is not usually reflected in accounting unless something has been paid for it. In this case, we must repay it over several years.

Issuance of Obligations

Obligations represent a share of the debt to society.

Types of Obligations:

  • American Coupon Obligations: A periodic payment of interest and repayment of the principal at the end of the bond’s life.
  • Zero Coupon Obligations: Not entitled to a periodic interest payment. At the time of repayment, the nominal maturity plus accrued interest to date is paid.
  • Debt Securities Issued at a Discount: The bonds were issued at a value lower than the nominal value and are repaid at maturity at the nominal value.
  • Obligations with Nominal Reduction: The gradual depreciation of the nominal value.
  • Indexed Obligations: The redemption value, the interest rate, or both together depend on an index taken as a reference.
  • Participatory Obligations: A fixed payment is made, to which a variable amount is added, which depends on the benefits of society.
  • Obligations to Variable Interest Rate: Obligations issued to more than one type of interest.
  • Convertible Obligations: Can be converted into shares. They are sometimes called deferred capital issues.
  • Option Obligations: Fitted with an option to purchase shares. If the option is separable from the title, we have a warrant.

Mutual Guarantee Societies

SMEs have difficulty obtaining credit due to a lack of sufficient guarantees to respond to credit institutions. To address these issues, Mutual Guarantee Societies (SGRs) appear, whose objective is to provide financial support to SMEs by providing a guarantee that supports the financial claims that have been given. We can define SGRs as financial institutions that cover their partners from the risks inherent in their management through business attitude. The aim of these societies is not to grant loans to their members but to provide collateral guarantees established in law to its members for all transactions that take place within commercial traffic. The capital of these companies is variable and divided into dues. The owner of a social quota has the condition of a partner and, therefore, all the guarantees established by law. The creation of two joint ventures or endorsements represented a measure of support and encouragement of SGR deficiency. The lack of state endorsement and the lack of rediscount operations guaranteed by the SGR led to the emergence of Refinancing.

Factoring

It is a contract whereby one party, called the assignor, assigns trade credits to another party, called the factor, so that the factoring company performs some or all of the following services:

  • Receivables Management: The factoring company handles the collection of receivables at maturity. The transferor must inform their customers of the signing of the contract with the factoring company.
  • Account Management: The factoring company provides the customer with all the information on the credits.
  • Coverage of Risks: The factoring company provides a hedge against insolvency.
  • Financing: The client can provide advances on invoices transferred.

Types of Factoring:

  • Factoring with Resources: The factoring company assumes the risk of non-recourse insolvency.
  • Factoring without Resources: If someone does not pay an invoice, the factoring company will not take the risk of the operation.

Venture Capital

It is a set of financial and consulting services channeled to small and medium-sized innovative companies, existing or under construction, or in a minority and temporary position, with the expectation of achieving significant gains in the form of either shared or non-debt. The purpose of these entities is that the gains obtained from successful projects compensate for the loss of those that fail. In Spain, this instrument has been used to facilitate the development of regions with low per capita income across societies that are installed in regions of lower sales per capita.