Consideration of uncertainties in business valuations

Introduction

Company valuation is actually impossible because it concerns the future and this is uncertain. Nevertheless, company values are necessary for many reasons, so the question arises as to how these uncertainties can be taken into account in valuations.

Traditionally, the past is used as the basis for planning, i.e. it is more or less simply extrapolated. Now, in view of current experiences (corona pandemic, Ukraine war, inflation and energy crisis, to name but a few), the hope remains that these will not become perpetuated. On the other hand, however, we must also expect new and as yet unknown developments or developments that are not considered probable or are considered unlikely.

In order to be able to produce reliable valuations as a basis for economic decisions even in times of increased uncertainty, the selection of suitable procedures and the appropriate handling of risks are of particular importance.

In principle, uncertainties or risks can be taken into account above the line – in the numerator or in the cash flows – or below the line – in the denominator or in the cost of capital. The decisive factor is that there is no double counting and that the denominator matches the numerator (equivalence principle), i.e. that the cost of capital adequately reflects the fluctuations in cash flows.

Up to now, valuation practice has largely been based on single-value planning. This paper aims to show how the classical valuation approach can be extended by sensitivity analyses, scenario calculations and simulations in order to move from pure point estimates to robust value ranges that may reflect reality more accurately.

Sections 2 and 3 present the basics of valuation theory and the cost of capital, before going on to discuss the three approaches to accounting for uncertainty in business valuation.

Read the full article from the Jahrbuch Treuhand und Revision 2023 (in German) here.