Valuation is way of estimating how much something is worth. The most common items that are usually valued are financial liability and assets. Valuations may be done on assets, for instance on investments of securities such as patents, stocks, trademarks, options and business enterprises or on liabilities such as the bonds provided by the company. Valuations have many purposes. It is practiced to answer many questions prior to litigation, investment analysis, tax liability, capital budgeting, financial reporting and acquisition and merger transactions.
Valuation is also done to check if the value given and reported is appropriate and accurate. If these assets are not well valued, it may ruin accounting documents which in turn may lead to problems in accounting audit, tax liability and many other issues.
There are other form of assets which are valued in a more independent and unique ways. In these cases, the valuation of the assets may be more complicated. For example, an intangible asset such as a copyright is hard to assign value. The same as the real estate, this may require an evaluation of the same real estate in the current market condition to be able to arrive in a reliable and accurate valuation that shows the fair market value of the asset.
If in case the assets are overvalued, the company may seem to be worthy compared to its public reporting. On the other hand, if the assets are undervalued, the company is set to be in abnormal stage of low value that may lead to complication on tax liability since tax authorities may check the assets which are undervalued and recalculate the tax of the company along with this information. Repetitive errors on valuation of assets may result to suspicions of fraud instead of innocent errors.
Valuation of different financial assets may be made with the use of these models:
1. Absolute Value Models– which show the present value of the future cash flow of the asset. These takes two major forms: multi-period models like discounted cash flow and the single-period models like the Gordon model. All of these models depend on mathematics instead of price observation.
2. Relative Value models-present the value according to observation of the prices of the same assets.
3. Option pricing models– are commonly used in many types of financial assets and are complex value models. The two most common options are the lattice models and the Black- Scholes- Merton models.
Common terms used to define the value of a liability or assets are intrinsic value, fair market value and fair value. These terms, however, differ in meaning depending on what field they are used.
Valuation is very important in many institutions such as banks, insurance companies and more. This is quite important since it provides the value of the assets of the company which will determine if the company is still making a good business in the industry. Although, there are different methods used in every company, valuation is still a must although the process may take time.