Valuation accounting is a term you may encounter in financial magazines and business publications. Simply put, it is a process by which the potential market value of an entity, through its assests or liabilities, is estimated. With the assets of a business, what can be included in valuations are options, stocks, business enterprises, and assets that are intangible (for example, trademarks and patents). As for liabilities, what can be included are company-issued bonds. There are usually three models that are used when doing valuation of financial assets, and these models can be used individually or in combination with each other. Relative value models ascertain the value of the asset based on the prevailing market prices of similar assets. Meanwhile, discounted cash flows determine the value of the asset by making an estimate of the potential future earnings from owning the asset brought to their present value. The third valuation model is the most complicated, called the option pricing model. This model is used in certain financial assets only.
An important factor in doing valuation accounting is timing. The reliability of a business valuation largely depends on the date when it was done. It is because a valuation does not only show the value of a business at any time, but it actually how the value of a business at a specific date. Valuation accounting should indicate the current value of a business, and the less recent a valuation date is, the less reliable the valuation report becomes. Thus, it is important for valuation accounting to be done more regularly. This is because there are some changes that can happen anytime that can affect a valuation. These factors include changes in the demand of products that a company produces. For example, a company that produces beepers would have a lowered demand for their products, and thus would have a different valuation nowadays compared to their valuation last decade. Other factors that may affect the valuation of a business would be the general economic situation, the competitive situation of a company, and a change in the management of a company.
The importance of valuation accounting is indispensible. For one, even on a stable climate, a business could still benefit from knowing which direction it is going, something that valuation can indicate. Periodic valuation accounting can let leaders of a business determine which strategy they have employed works, as the company will show an increase in its value. Furthermore, valuation can also pinpoint which department in a company would need more support and funding and which segments can stand on its own without too much focus. Valuation is also a reliable tool in showing the life cycle of a particular industry. If the value of a company is decreasing over time, then that may mean that the marketing strategy is failing or that the demand for the product or the entire industry is dwindling. This may be taken the management of the company as a sign to cut their losses and exit the industry.
Valuation accounting can be used in different situations and can be slanted for these goals. Different aims for a valuation can be tailored depending on why the valuation is done. For example, if a valuation is done for the purposes of financing, it will be banks or lending institutions that will read the valuation report, and they would be looking for a valuation that focuses on the value of the company upon liquidation rather than the value of the company as an ongoing business. If a valuation is done for the purposes of sale, then the company should arm itself with a valuation that indicates the highest possible value of the company. Meanwhile, for the purposes of tax, such as gift and estate tax, the lowest possible valuation is ideal for the business to stay away from tax liabilities. Lastly, for the purposes of litigation, make sure that the goals of the valuation would side on your case.
For practical purposes, valuation accounting can be done for a variety of purposes. As earlier mentioned, timing is important in valuation. So, if you are in the midst of some major changes within your company and within your life, you might as well check with your lawyer or accountant if valuation can be done. A partnership dissolving and a credit or loan application or even something as personal as a divorce of a company boss should trigger for a valuation to be done. Circumstances that may need for the company to be assessed for whatever reason may be valid reasons for a valuation.