Value as a concept has different meanings for different people. The value of an object changes from time to time as well. Hence, value is a relative term and depends on people, perceptions, time, and circumstances.
The value of a luxury item can vary according to the income level, perceptions, and usability of the item. When the value of an item is equal to or greater than the base price, then the sale will occur.
Business valuation is a process used for estimating the economic value of the whole business. Valuation is used to arrive at the price which the market participants are willing to pay or receive at the time of sale of a business. In business valuations, the whole business will be valued on the basis of the concept of value that has been defined so as to ensure common comparison and analysis between different concepts of value.
Each of the terms have been explained here:
1. Book Value
The value at which the assets and liabilities are recorded in the books of accounts of the entity is called the book value. The value will be uniform due to the common accounting principles used in recording the value of assets and liabilities.
2. Depreciated Value
The value derived after deducting the depreciation or amortisation of the assets of the business/entity is the net amount. This net amount is called the depreciated value or written down value.
3. Going Concern Value
The concept of going concern value is used by many businesses for evaluation purposes. This concept measures the value of assets which are ‘in use and working’ on a daily basis in the business. It is based on the idea that the business will operate indefinitely and will continue to be profitable.
4. Liquidation or Break up value
This is the value that is assigned to the assets on winding up. Upon winding up, the assets of the business will be realised in a shorter time, and hence they will be realised at the full value. This will generally be the price that would be achieved at a public auction.
5. Fire sale value
This is the emergency value of the asset. It is the price at which the asset can be sold in the shortest possible time despite being lower than the market value. The goods which are sold at a discounted price is the fire sale value.
6. Intrinsic Value
This is based on the ‘true worth’ of an asset. This value can be higher than the market value, as the market value can be undervalued due to certain assumptions. Hence the intrinsic value is the theoretical actual value of an asset.
7. Fair Market Value
Fair Market Value is the estimated price for the transfer of property between knowledgeable and willing parties that reflects the interests of the parties.
Fair Market Value and FairValue have certain similarities and hence are used interchangeably.
Fair market value has the following assumptions:
- Open and Unrestricted Market – A market with perfect competition; however, in some cases, there can be regulatory restrictions.
- Knowledgeable, willing buyer and seller – Understands the business and the issues and also the economic rationale that backs the business valuation that the investment reflects risk and return.
- Not Anxious buyer and seller – They are not subject to external pressures, and the transactions are based on the merits of the investment itself.
- Arm’s Length – Transaction between two individual parties.
Therefore the fair market value is the price that is negotiated between a knowledgeable, willing buyer and a knowledgeable, willing seller who is not anxious, and the transaction occurs at arm’s length in an open and unrestricted market.
Fair Value is the estimated price of the goods listed on the company’s financial statements. It is the price at which the transfer of a property takes place in an orderly manner between defined parties on a predetermined date.
The important differences between fair value and fair market value are as follows:
- In fair value, the identity of the parties is relevant as opposed to hypothetical.
- In fair value, the parties may not be at arm’s length.
- In fair value, certain synergies may be present that are known to both parties.
8. Replacement Value
Replacement value is the value that is determined by the cost involved in replacing an existing asset. One of the key factors that determine the decisions to buy or build an asset is the replacement value.
9. Strategic Value
Strategic value is the value that a purchaser is willing to pay over and above the fair market value of the business. This value is determined as an add on and assumes that specific benefits accrue or are expected to accrue to the investment. Examples of the same are specially skilled employees, cutting edge technology and innovation, market reputation, goodwill.
The business valuations can depend on the above concepts of values, and accordingly, the various methods can be deployed to value the business.
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