What is a Going-Concern Business?
Going concern refers to the economic unit that is presumed to be in continuous existence and that will continue in operation for the foreseeable future. The commercial unit or economic unit is in operation and generates economic benefits, this definition is based on the basic postulate of the NIF A-2 (Financial Reporting Standards).
A Going Business Appraisal is an accounting term for a company that has the necessary resources that allow it to continue operating without the sight of future threats of a liquidation, where the value of a company is considered as a whole that is subject to both to its economic and financial environment in which it develops.
Going concern can be valued using widely used valuation approaches, such as the comparative market approach, the cost-based approach, and the income approach. An entity shall use valuation methods consistent with one or more of those approaches to measure fair value (IFRS Foundation, 2019).
What factors are taken into account in the valuation?
When evaluating a company, both internal and external factors must be considered. Since the company is affected by its environment, the factors to consider that can affect the value of a company positively or negatively are the following:
- History of the company.
- Environment in which it operates.
- commercial factors.
- technical factors.
- Human factors.
- Financial Factors.
- Other factors (legal, administrative, etc.)
- Evolution of the country economy where the company is located.
- Evolution of the economy of the countries where the company works.
- Evolution of the economy of the sector to which the company belongs.
How is the value of a going concern composed?
The going concern is an entity with economic activity that is constituted by a set of fixed assets linked to intangible assets and integrated according to a set of technologies that allow it to produce goods or provide services.
It is important to recognize that these types of assets are important to carry out the valuation of a going concern, where the real value of the assets tangible and intangible comes from its ability to generate future economic benefits.
The value of a company is determined by:
- Brands and trade names.
- Patents and related technology.
- Computer software / systems / databases.
- Customer lists, business relationships.
- Favorable contracts, leases.
- Non-compete agreements.
- Furniture and office equipment.
- Computer equipment.
- Machinery and equipment.
- mineral deposits.
What are the characteristics of this appraisal?
A “going concern” is considered to be one that will continue in operation for the foreseeable future.
This type of study allows the businessman to have a clear and concise idea about his financial situation, which allows him to measure the profitability and liquidity of his business.
This appraisal must consider the internal and external factors in which the company is located, since they influence its socio-economic context before the valued objectives.
One of the main characteristics that the ongoing business must meet is to verify to the appraisal agency that it is, indeed, able to continue operating; the company must do so by preparing its financial statements under the going concern assumption.
In the event that the company's management considers that it is no longer in a position to be considered a going concern, then it will not prepare its financial statements under the going concern assumption.
How is a running business valued?
It is important to accurately identify which valuation techniques or methods are most appropriate to the circumstances, on which there is sufficient information and data to measure the fair market value of the Going Concern, as appraisers, we must maximize the use of input data. more observable and relevant.
The objective of using a valuation method is to estimate the fair market value at which an orderly sale transaction of the asset between market participants would take place on the measurement date under current market conditions. Likewise, for any other purpose, the appraiser will identify the most appropriate method.
The IFRS identifies three widely used valuation methods: Market focus, cost focus and income focus. It also states that an entity will use valuation methods consistent with one or more of those approaches to measure fair value.
Judgment must be used to establish whether the fair value of the Going Concern can be determined with sufficient reliability with each of the aforementioned methods.
For example; When there is an observable market of purchase and sale transactions of comparable economic units, we can use the market approach; however, when this set of data is poorly observable and there is not enough comparable data within the market, it will be necessary to consider the other two approaches, the same will happen for the income and cost approach, for the income approach, it will be very important to count the financial statements of the business, and apply the most assertive valuation methods.
In this way, as a valuation unit, the most appropriate valuation criteria and methods will be applied for the circumstances in which said economic unit is found.
What methods are used for the appraisal of a going concern?
This method estimates the value of a property or economic unit that considers the possibility, as a replacement for it, could be built and put into operation with an equivalent utility.
The result obtained from this approach is the replacement value, the replacement value is equal to the cost of acquiring a company with the same production and profit generation capacity as the company being valued, the replacement value is based on current market prices and takes into account the use of the assets and their corresponding wear and tear, the value requires an estimate of the fair market value of all the components that make up the company.
This method estimates the value of a going concern taking as reference some indicators and financial ratios related to the sale price at which a recent transaction was carried out whose object was a similar company and from the same sector.
This method is based on comparing the assets of both economic units in terms of installed capacity, geographic location, sales time, level of financing and sales conditions, as well as operational and financial indicators. The comparison of these indicators will help us make a homologation of value between companies and in this way the fair market value of the business is determined, this comparative analysis will only be possible in those sectors whose nature determines homogeneous companies.
This method, by requiring an investigation of supply and demand, and comparable business transactions in an open market, which, depending on the sector, turns out to have a high degree of complexity due to the lack of information that exists, especially in America. Latina.
This valuation method establishes that the value of the company is the result of the sum of the present values of future free cash flows (Free Cash Flow – FCF). Thus, the projected cash flows of the company are brought to present value discounted at a discount rate relative to the company, this rate is called WACC (Weighted Average Cost of Capital).
The FCF (Free Cash Flow) method is the most widely used valuation method and recognized for its efficiency in estimating going concern value, which is why it constitutes the basis on which the concept of creating value is developed. worth.
This method even makes it possible to carry out asset valuations and also to estimate the value of strategic and operational alternatives for companies. This method provides us with complementary information such as knowing the risk and the rate of return for the shareholder, the effect that financial indicators have on the value of the company and the effect that macroeconomic variables have on the value of the business in march, and in general for a great variety of decision-making.
Within the Free Cash Flow method there is the FCFF (Free Cash Flow to Firm) and the FCFE (Free Cash Flow to Equity), but What is the difference between these two concepts?
FCFF (Free Cash Flow for Firm) is the firm's measure of value that calculates the cash flow that is generated after deducting all expenses, taxes, and changes in net working capital. And on the other hand, the FCFE (Free Cash Flow for Capital) is the value that is distributed among the shareholders of any business after deducting expenses, taxes, changes in net working capital and additionally the payment of the debt.
Some most used models:
- Free Cash Flow to Firm
- Black & Scholes
- Monte Carlo
Why is a Going Business Appraisal necessary?
Finding more appropriate ways to identify, measure and manage the risk/return relationship will provide companies with a clear competitive advantage, as they will give them better tools to diagnose problems, find solutions and anticipate consequences.
The valuation of ongoing businesses is a method that makes it possible to identify, measure and manage this risk/return relationship, in addition to being a fundamental process in all acquisition, sale, merger, investment analysis, capital placement on the stock market, and in many cases, to evaluate and remunerate managers.
Some of the most common objectives are:
Buy and sell
- Share Restructuring
- Series Change in Actions
- Valuation of Listed Companies
- Probate successions
- Identification and prioritization of Value Drivers
- Strategic business continuity decisions
We are a company with experience in various types of appraisals, we provide security and certainty with highly trained personnel, if you are interested in any of our services we can provide you with advice. Contact us.