3.4 Use of Financial Statements in Valuation

The value of a business depends on the context. Sometimes it is --

• the price at which a seller and buyer actually transact -- as when a securities rule refers to "market value."
• the amount that a contract or other document dictates -- as when bylaws specify that a withdrawing minority shareholder is entitled to "adjusted book value."
• the pro rata share of an ongoing business -- as when a court determines "fair value" in a statutory appraisal proceeding.
• the price a hypothetical seller and buyer would have negotiated -- as when a judge determines "fair market value" for estate tax purposes or in divorce proceedings.

In many of these situations, the financial statements of the business provide a starting place to calculate (or make assertions about) value.

3.4.1 - Book value

Book value represents the the net worth (or equity) of the business -- assets minus liabilities -- as shown on the company's balance sheet. It is relatively easy to calculate, but provides a terribly deceptive picture of value. .Financial statements are based on historical cost and do not reflect how much somebody would pay for the assets, much less the ongoing business. Book value typically does not reflect goodwill' or of the company's earnings potential. (More 3.4.1>>)

3.4.2 - Cash flow

Company cash flow or earnings is the most popular method for valuing a company as a going concern. The value of the company is based on projections of what its earnings or cash flow is likely to be -- using past trends to predict the future. (More 3.4.2)

3.4.3 - Comparables

(More 3.4.3>>)

Equity Funding scandal (1960s)

Corporate scandals (2000s)