ACC 6000 Business Valuation Using Financial StatementHow Do You Conduct Business Valuation by Using Financial Statements?
Answer
Business valuation is a process of determining the economic value of a company or business.
Financial statements are a critical component of business valuation because they provide key
financial information about a company.
Determining a business’s value is crucial when a company wants to prepare for a merger,
plan to sell the business, or understand where the business’s position stands in the industry
landscape. A business valuation is required to determine its economic value to get accurate
information. During the process, the company’s management, future earnings, the market value of
assets, and capital structure are analyzed to obtain the current worth. One of the standard methods
to get business value is the use of financial statements that include balance sheets, income
statements, and statements of cash flows.
Data found in all financial statements are used to calculate financial ratios that provide an
understanding of the business’s financial performance and issues that may require to be solved
(Palepu & Healy, 2013). Each of the statements has varying details with information that is
interconnected. By analyzing these documents, business owners and potential buyers can assess
the company’s financial position and future performance.
The first approach to conducting a business valuation using financial statements is to
analyze the balance sheet. A balance sheet is a document that provides a snapshot of a company’s
assets, owner’s equity, and liabilities at a given point in time. A business’s value is calculated by
calculating the total assets owned by the company, less its liabilities (Koseoglu & Alemeany,
2020). The assets are divided into current and non-current, sorted depending on liquidity and
maturity. Examples of assets include cash, accounts receivable, inventory, and equipment, whereas
liabilities include accounts payable, taxes, and loans.
Investors gain insight into the company’s profitability, liquidity, and solvency by analyzing
the balance sheet. A balance sheet lists everything it owns and all debts. Additionally, investors
determine the company’s net worth, which is the difference between assets and liabilities. Once
the value of the company’s assets is determined, the equity value is calculated. It is the value of
the business’s equity after subtracting the value of its liabilities. The equity value is the amount
that investors would be willing to pay for the company’s stock if the company were to be sold.
“Balance sheet information gives a general understanding of business value, nevertheless, it does
not provide an accurate and complete picture” (Koseoglu & Almeany, 2020). Therefore, balance
sheets have advantages and disadvantages in demining business valuation.
The following approach is analyzing the income statement. Unlike the balance sheets, this
approach shows the company’s revenue, expenses, and profits over a given period. Direct expenses
are categorized into the cost of sales subtracted from revenues to obtain the gross profit. Gross
profit is later analyzed compared to all sales made to determine a business’s gross profit margin.
According to Schmidlin (2014), “when comparing to other firms, the gross profit margin shows
the price input of a company.” Therefore, by analyzing the income statement, investors can gain
insight into the company’s profitability, cash flow, and overall performance.
Indirect expenses are also essential in an income statement. They show the total costs
associated with activities generating the company’s revenue; for instance, administrative expenses,
salaries, depreciation, and research and development. According to Schmidlin (2014), all the
expenses are deducted from gross profit to determine operating income. In addition, capital
expenses such as taxes and interests provide a company’s net income total earnings. The net
income, operating income, and gross profit margin help analysts determine the business’s value
depending on its profits or losses and help the management make decisions.
The value presented by cash flows also determines the present value of a business.
According to Koseoglu and Almeany (2020), cash flow determines a company’s value by providing
insights into the cash movement in and out of a company. The company’s activities are divided
into investments, operations, and financing activities; this information provides a historical record
of cash flow. The cash flow statement provides an accurate, historical valuation. One of the primary
cash flows is the free cash flow which is the money that would be available for a business after
working capital requirements and covering fixed assets investments, assuming there are no
financial expenses and debts (Schmidlin, 2014). Generally, cash flow statements assess a
company’s ability to generate cash from its operations and determine the amount of cash available
for debt repayment and investments.
Using the cash flows to determine the company’s current value is also done using
discounted cash flow (DCF) analysis. In this method, a business is viewed as a cash flow
contributor, and a company’s value is determined by calculating cash flows’ present worth using
an appropriate discount rate (Palepu & Healy, 2013). In determining the present value of the
company’s future cash flows, a business takes the expected future cash flows, discounting them to
the present and subtracting the company’s current liabilities.
To conduct a business valuation using financial statements, a company needs to gather
relevant financial records, such as the balance sheet, income statement, and cash flow statement.
Once these documents have been gathered, their information is analyzed. The analysis is conducted
by calculating vital financial ratios, such as the price/earnings ratio, debt/equity ratio, and net
worth. These ratios provide valuable insight into the company’s profitability, debt levels, and
assets, which can be used to calculate the current value.
Consider other factors that may affect the value of the business, such as market conditions,
industry trends, management team, and competitive landscape. Prepare a written report that
outlines the valuation process, assumptions, and conclusions. Overall, business valuation is a
complex process that requires a deep understanding of financial statements and valuation methods.
It is important to work with a qualified professional to ensure an accurate and objective valuation.
References
Köseoğlu, S. D., & Almeany, S. S. A. (2020). Introduction to business valuation. Advances in
Business Information Systems and Analytics, 1–23. https://doi.org/10.4018/978-1-7998- 10865.ch001
Palepu, K. G., & Healy, P. M. (2013). Business analysis and valuation. South-Western, Cengage
Learning.
Schmidlin, N. (2014). The art of company valuation and financial statement analysis: a value
investor’s guide with real-life case studies. John Wiley & Sons.
Question 5: Describe the concept of gift splitting and the annual gift exemption and how
each of these concepts can be effective tax planning tools for individuals.
Answer
Gift-splitting is a tax minimization strategy by a taxpayer through distributing the value of the gifts
over the periods. Splitting the value of the gift will enable the taxpayer to avail the certain
allowable deduction given by the government for a year, over more years.
For example, the government allows 250,000 deduction of gifts for every year, and the value of
the gift is 500,000. Instead of giving the 500,000 in one year where the tax basis will be 500,000250,000=250,000), the donor may split the value into two years (where the tax basis will be
500,000/2=250,000-250,000 deduction=0), hence there will be no tax payment for the two-year
period. This is a legal way of minimizing payment of taxes.
Question 6: Describe the pros and cons of each of the following entity types. Include
discussion on the tax structure (such as double taxation vs. flow through taxation) and
provide examples of basic tax planning common for each entity type. Include discussion on
whether there are there any non tax considerations that should also be considered when
deciding which entity to operate as.
1) C Corporations
2) S Corporations
3) Partnerships/LLCs
Answer
The most widely recognized types of business ventures being used in the United States are the sole
ownership, general organization, restricted risk organization (LLC), and partnership. Each
structure has preferences and disservices in unpredictability, simplicity of arrangement, cost,
obligation insurance, occasional detailing prerequisites, working intricacy, and tax collection.
Likewise, some business structures have sub-classes, for example, the C enterprise, S organization,
and expert partnership. Picking the correct business structure requires a sensitive adjusting of
contending contemplation’s. Figure out how to choose, plan, and arrange the business structure
that is an ideal fit for your company
C Corporation
All organizations (even S corps) start as C partnerships. If you keep up a joined business in the
United States and you haven’t petitioned for S corp or LLC status, you’re consequently viewed as
a C enterprise by the IRS. Individuals fuse for bunches of reasons—to formalize their business,
free it up to new speculation, bring down their expense bill, and so forth. In any case, the primary
explanation individuals do it is that it gives their business a superpower called restricted
obligation. Constrained obligation gives the proprietors of enterprise insurance from that
organization’s lenders. This implies if the organization you own ever fails, your leasers can come
after the company’s benefits, however not your advantages.
Advantages
1)It formalizes the business
Perhaps the most excellent choice entrepreneurs need to make when joining is making sense of a
value split—or, the amount of the business every proprietor will get the opportunity to keep. Do
you incline that you’re doing a lot of the work in your business? Consolidation allows you to carry
that up with your prime supporters and think of a value split that mirrors that.
2) It may bring down your duty charge contrasted with a sole ownership
Enterprises pay a charge at an extraordinary corporate expense rate that is not the same as (and
regularly lower than) the individual duty rates you pay when you run sole ownership. This is
particularly evident under the new Tax Cuts and Jobs Act, which diminished the C corp charge rate
to a level 21%…
3) It starts the business to speculation
Consolidating makes it significantly simpler for others to put resources into your business,
principally because it lets you issue stock (for example, shares in the organization) and have
investors. Financial specialists are much all the more ready to give you cash if they get a stock
testament in return for it, as opposed to a straightforward handshake or IOU.
Disadvantages
1) It’s costly to fuse
Contrasted with different business structures like sole ownership (which you start naturally just by
working together) and associations (which you can shape with a handshake understanding), it’s
costly to begin and run a C organization. Contingent upon how and where you consolidate, the
entire procedure could cost you a great many dollars.
2) It includes bunches of guidelines and desk work.
C corps need to follow numerous guidelines at the government, state, and nearby levels. If you
join as one, you’ll presumably need to do much more desk work than you would work an
organization or sole ownership. Also, recall that when you consolidate, that is an entirely different
arrangement of money related and charge records that you need to monitor, which could suck up
a great deal of your time.
3) It may cost you more in charges
Fuse can leave some entrepreneurs with an expanded taxation rate. Companies don’t approach
similar credits that people have on their expense form. On the off chance that you consolidate, you
can’t decrease your salary by any misfortunes you continue—you’ll need to convey them forward
into another assessment year.
S Corporation
S Corporation status is an exceptional assessment assignment conceded by the IRS that lets
companies pass their corporate salary, credits, and findings through to their investors. As a rule, S
enterprises don’t make good on personal assessments. Rather, the organization’s shareholders split
up the income (or losses) amongst each other and report it on their tax returns, letting them avoid
double taxation.
Advantages
1) You evade twofold tax assessment
As we referenced above, C enterprise salary is charged at the corporate and individual level, while
S organization pay is just charged at the personal level. If your organization is making a benefit
and you need to remove a portion of that cash from the organization, it’s commonly less expensive
to do as such as an S corp than a C corp.
2) You may decrease your independent work charge bill
In contrast to proprietors of sole ownership, organizations, and LLCs, S corp proprietors just
compensation independent work burdens on their wages as opposed to their whole portion of the
organization’s benefits. All other salary is paid to investors as “circulations” that are not dependent
upon independent work charge, which makes S partnership status appealing to numerous private
companies.
Drawback
1) Strict prerequisites
On the off chance that your organization neglects to meet any of the IRS’s prerequisites for S
partnership status anytime, the IRS can repudiate it quickly and charge it as a C enterprise rather,
which could make immense issues around charge time.
2) Closer expense investigation
The IRS watches out for whether the “sensible” compensations corporate officials are paying
themselves are, to be sure, sensible. On the off chance that the IRS speculates an investor has come
up short on compensation to diminish their taxation rate, they may rename a few circulations as
wages, which could build the investor’s assessment risk fundamentally.
The Partnership
An association is a business structure made consequently when at least two people take part in a
business venture for benefit. Consider the accompanying language from the Uniform Partnership
Act: “The relationship of at least two people to carry on as co-proprietors of a business revenuedriven structures an association, regardless of whether the people expect to shape an organization.”
An association – in its different structures – offers its numerous proprietors adaptability and relative
straightforwardness of association and activity. In restricted associations and constrained
obligation organizations, an organization can considerably provide a level of risk assurance.
Advantages of the Partnership
•
•
•
Proprietors can begin associations moderately effectively and modestly.
Associations don’t require yearly gatherings and need hardly any progressing customs.
Organizations offer ideal tax assessment to most littler organizations.
Disadvantages of the Partnership
•
•
All proprietors are dependent upon boundless individual obligation for the obligations,
misfortunes, and liabilities of the business (except for in the instances of restricted
organizations and constrained risk associations).
Singular accomplices bear obligation regarding the activities of different accomplices.
The Limited Liability Company (LLC)
The constrained obligation organization (LLC) is America’s most up to date type of business
association. There is a minimal recorded point of reference for LLCs. They are manifestations of
the state lawmaking bodies, albeit a few pundits follow the starting point of the LLC to a
nineteenth-century type of business association called the organization affiliation, or constrained
association affiliation.
Advantages of the LLC
•
•
•
LLCs don’t require yearly gatherings and require not many progressing conventions.
Proprietors are shielded from individual risk for organization obligations and
commitments.
LLCs appreciate organization style, go through tax assessment, which is favorable for
some private companies
Disadvantages of the LLC
•
•
LLCs don’t have a dependable group of legitimate points of reference to control proprietors
and directors, even though LLC law is getting increasingly stable over the long haul.
An LLC isn’t a proper vehicle for organizations looking to become open in the end, or to
fund-raise in the capital markets.
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