subject: Valuations for Financial Reporting in Today's Market [print this page] Valuations for Financial Reporting in Today's Market
This article discusses the major problems that face valuation professionals in the finance industry. Many companies are moving towards an income approach at valuating and moving away from the market approach. This is a problem because the market is not properly priced and results in a significant variance between the two methods.
The difference between the two methods seems to result from the market and it valuing companies much lower than the income approach. This large variance is hard to reconcile and makes impairment testing a challenge for analysts. Companies may be lead to believe that there is not impairment to be tested if they utilized the income method. Another problem is that companies maybe trading below their liquidation value, although, those companies are actually profitable.
Another concern that is discussed by the panelist is that the historical data that is being used to value companies is too brief. A majority of these reports only go back about five years. Five years has become insufficient especially for smaller companies because of the current state of the economy. Analysts need to look further back in order to evaluate if the particularly low numbers are considered normal for the company and industry.
In addition, analysts are adding to their review by taking a look at forecasted predictions and actual numbers for the period. This allows analysts to test the reliability of forecasting reports.
I agree with the panelist and their concern with the variance that occurs when switching from a market approach to an income approach. Both perspectives are important to consider when investing in a company. Additionally, I think from an investor perspective it's important to evaluate the industry trends so that investors can see if companies are operating in an acceptable range despite the economic downturn.
It is also important to not utilize the method that makes the company appear more desirable, whether it is the income approach or the market approach. Companies should attempt to reconcile the variance that results from the two approaches to obtain a conservative number that will not be misleading to investors.
The panelists bring up a lot of valid points when it comes to valuation of companies during this difficult economic period. Investments are much riskier and require a lot more vetting than previous years and companies as well as analyst need to take that into account during valuations. They need to take more than one perspective when they are valuing companies to accurately represent the firms in this period when the market is down.
