In view of the increasing demand of valuation services, certain organizations have begun to conduct surveys and market studies on valuation practices and issues, such as valuation approaches and parameters, in different countries. This newsletter will discuss the common approaches adopted in the valuation industry based on a number of surveys and studies conducted by professional services firms in 2017.

For the three most common valuation methodologies (i.e. income approach, market approach and cost approach):

A. ASEAN countries (including Singapore, Indonesia and Malaysia)
In Singapore, 88% of respondents often use the income approach and 81% often use the market approach. Only 16.5% of respondents often use the cost approach.

B. Australia
In Australia, market approach is the preferred methodology, regularly used by around 90% of respondents. Around 70% of respondents use income approach on a regular basis and less than 20% of those adopt cost approach.

C. Africa
62% of respondents from Africa adopt income approach as the primary valuation approach and the remaining 38% of respondents select market approach as the primary approach.

Some market trends and insights on valuation approach can be noted from the above findings:

1. Income and market approaches are the most popular methodologies adopted in valuations – Income approach is the preferred approach in ASEAN countries and Africa, while market approach is preferred in Australia. Each of them has its own advantages and limitations; selection of an appropriate approach requires valuers to understand the business nature and industry environment of the subject company. Sometimes, availability of market data can be a factor when selecting valuation methodology. For example, there are relatively few listed companies that are considered as a reliable source for market multiples in the African market and this may indicate why the income approach is the mostly adopted methodology in Africa. However, should professional valuers also consider other factors such as reliability of forecast to be adopted in income approach and insufficient number of listed companies for discount rate calculation? This is important for valuers to take into consideration of different qualitative and quantitative, company-specific and market factors before making the conclusion.

2. Cost approach is the least adopted valuation approach – Cost approach, also known as the adjusted net assets method in business valuation, determines the value of the overall business using the sum of the value of individual assets and liabilities recorded or not yet recorded on a company’s balance sheet and does not consider the “chemistry” to the business value when all assets and liabilities work together. This is the least adopted approach as it does not align with the common investment rationale on a company – to capture the full earnings power of a business.

3. More than one approach is adopted to conclude the valuation – The market studies / surveys indicated that the most common approach among the respondents is to use a primary approach and another as a cross-checking. Of those respondents in Africa who use the income approach as their primary methodology, most of them use the market approach as their secondary method of choice, and vice versa for those using market approach as the primary approach. In case of difference in valuation result between the primary method and the cross-checking, valuers should justify the reasonableness of the difference with their analysis, knowledge and experience.

In short, valuing a business isn’t always a simple or straightforward process. Professional judgment of valuers is already required in the first step of exercise to determine the most appropriate approach for a reliable valuation. Remember, “a good valuation is 75% art and 25% science because it takes into account the story behind the numbers of a business”, says Matthew Schubring, a valuer in the US with more than 15 years of experience in valuing companies. “Appraisals fall down when there isn’t enough support for the story behind it. It’s based not on just what happened, but on why things happened.”