Unit I:

Risk Analysis in Capital Budgeting

Strategic Financial Management

Introduction

In a world of economic uncertainty, the investors want to maximize their wealth by selecting
optimum investment and financial opportunities that will give them maximum expected
returns at minimum risk. Since management is ultimately responsible to the investors, the
objective of corporate financial management should implement investment and financing
decisions which should satisfy the shareholders by maximizing their wealth. Since capital is the
limiting factor, the problem that the management will face is the strategic allocation of limited
funds between alternative uses in such a manner, that the companies have the ability to sustain
or increase investor returns through a continual search for investment opportunities that
generate funds for their business and are more favourable for the investors. Therefore, all
businesses need to have the following three fundamental essential elements:
• A clear and realistic strategy
• The financial resources, controls and systems to see it through
• The right management team and processes to make it happen.

STRATEGY
Strategy is a course of action that specifies the monetary and physical resources required to
achieve a predetermined objective, or series of objectives.
Corporate Strategy: It is an overall, long-term plan of action that comprises a portfolio of
functional business strategies (finance, marketing etc.) designed to meet the specified
objective(s)
Financial Strategy: It is the portfolio constituent of the corporate strategic plan that embraces
the optimum investment and financing decisions required to attain an overall specified
objective(s).

Meaning
Management is ultimately responsible to the investors. Investors maximize their wealth by
selecting optimum investment and financing opportunities, using financial models that
maximize expected returns at minimum risk is strategic financial management.

Strategic Financial Management refers to the study of finance with a long-term perspective
which takes into account the strategic goals of the enterprise. Strategic Financial management
is a management approach which makes use of various financial tools and techniques in order
to come up with a strategic decision plan.

Definition
Chartered Institute of Management Accountants of UK (CIMA) defines strategic financial
management as “the identification of the possible strategies capable of maximizing an
organization’s net present value, the allocation of scarce capital resources between competing
opportunities and the implementation and monitoring of the chosen strategy so as to achieve
stated objectives.

NATURE OF STRATEGIC FINANCIAL MANAGEMENT

The important characteristics of Strategic financial Management are the following: -
1. It is concerned with the long-term management of fund with a strategic perspective
2. It aims at maximisation of profit and wealth of the concern
3. It is both structured as well as flexible
4. It promotes growth, profitability and existence of the firm in the long run and maximises
shareholder value
5. It is an evolving and continuous process that constantly tries to adopt and revise
strategies in order to achieve strategic financial objectives of the firm.
6. It involves innovative, creative and multidimensional approach for finding solutions to
the problems.
7. It helps to formulate appropriate strategies and facilitates constant monitoring of action
plans to match with the long term objectives.
8. It makes use of analytical financial techniques with qualitative and quantitative
judgment on factual information
9. It is result oriented combining of resources, especially of financial and economic
resources
10. Strategic financial management offers a number of solutions while analysing the
problems in the organisational context.

Importance of Strategic Financial Management

1. Helps In Detecting the Requirements of Capital In The Business:
The first and foremost function of financial management is that it initially estimates the
finance needed for the smooth running and functioning of the business. This is one of
the primary duties of financial managers. The finance requirements of every business
will vary due to the size of the operation, their profit target, and various other
objectives and mission.
2. Helps In Deciding the Composition of The Capital Structure:
Once the capital requirements of the business are calculated, now the next function
that needs to completed by the financial manager is deciding what type of capital
structure should be there. This basically involves the choices between the short-term
and long-term sources of funds and also takes into consideration the cost involved in
the raising of this finance.
3. Helps In Choosing Right Source of Funds:
As there is a different source of raising funds are available in the market. This step
simply aims at choosing the most appropriate and accurate one. The common types of
fundraising methods are raising funds through issuing shares & debentures, simply
taking loans from the financial institution, or through the issuance of securities like
bonds.
4. Allocating And Investing in Finance Raised:
Now after the accurate amount of funds is raised then these funds are invested in
various means that are revenue-generating for the business and are also in line with the
objectives and goals of the business.
5. The Utilisation of The Surplus Amount:
 It is concerned with a decision regarding the profit generated by the business and how it
should be utilized and there are basically two options available for this profit utilization
that are either excess profit should be used for distribution as a dividend or for the
retained earnings depending on the future plans of the company.
6. Controlling All Cash Expenses:
This simply means management of the cash so that neither of the expense goes out of
the budget. It consists of various expenses where cash payments are to be made like
salaries and wages payments, and expenses of water and electricity bills, and also the
amount required for the purchase of the raw materials, etc.
7. Controlling All Finance:
It is one of the important function as it is the one which plays a very effective role in the
accomplishment of the goals and objectives of the business. It makes sure that whether
all the activities are going in accordance with the pre-decided plans and if not accurate
control measures are taken.

FUNCTIONS OF STRATEGIC FINANCIAL MANAGEMENT:

Functions Performed by Strategic Financial Management

Strategic financial management encompasses the entire spectrum of financial activities
performed by any organization.
1. Continual search for best investment opportunities
2. Selection of the best profitable opportunities
3. Determination of optimal mix of funds for the opportunities
4. Establishment of systems for internal controls
5. Analysis of results for future decision-making.

1. Decisions Regarding Capital Investments: The point of view of strategic financial

management makes organizations view their capital investment decisions in a new light.
For example, the recent 15-20 years have seen the emergence of asset-light businesses.
For instance, Uber, Airbnb, Facebook are all leaders in their own industries. However,
they own very few assets. Companies that use strategic financial management to make
decisions about their long-term assets would have noticed this trend earlier than other
companies. Hence, they would have invested in making long-term commitments
towards illiquid assets which may end up providing a sub-optimal return in the long run.

2. Decisions Regarding Location: Companies that take a strategic point of view about their
investments also use different methods to select where they will locate their business.
For example, many American companies have been located in China in the past.
However, if the decision were to be made now, fewer companies would choose to locate
in China. This is because of the continuous tensions and trade wars between the two
countries. This is what makes long-term location in China a riskier proposition than
locating in another country that may be slightly more expensive in the short run but less
prone to trade wars in the future.

3. Decisions Regarding Mergers and Acquisitions: Strategic financial management helps

companies take a careful look at their business models. It is during this deep dive that
companies often discover whether organic growth is best for them or whether they too
 can choose the inorganic way. The guiding principle remains the same. If the company
can absorb the costs of acquiring another company and add value in the long run, such
an acquisition would be justified. However, strategic financial management ensures that
companies keep their long-term goals in mind before taking a decision regarding an
acquisition. involve prioritization and control of a corporation’s projects to align with the
strategic goals. The investment is done in varieties of commodities and shares so that
the company will never face the losses.

STRATEGIC FINANCIAL MANAGEMENT DECISIONS

Investment Decisions: One of the tasks in corporate finance is to make capital investments, and
the corporate finance department is responsible for the deployment of a company’s long-term
capital. The decision process of making capital investments is mainly concerned with capital
budgeting, a key corporate finance procedure. Through capital budgeting, a company identifies
capital expenditures, estimates future cash flows from proposed capital projects, compares
planned investments with potential proceeds, and decides which projects to include in its
capital budget.
Financing Decisions: is yet another crucial decision made by the financial manager relating to
the financing-mix of an organization. It is concerned with the borrowing and allocation of funds
required for the investment decisions. The financing decision involves two sources from where
the funds can be raised: using a company’s own money, such as share capital, retained earnings
or borrowing funds from the outside in the form debenture, loan, bond, etc. The objective of
financial decision is to maintain an optimum capital structure, i.e. a proper mix of debt and
equity, to ensure the trade-off between the risk and return to the shareholders.
Liquidity Decisions: It is very important to maintain a liquidity position of a firm to avoid
insolvency. Firm’s profitability, liquidity and risk all are associated with the investment in
current assets. In order to maintain a trade off between profitability and liquidity it is important
to invest sufficient funds in current assets. But since current assets do not earn anything for
business therefore a proper calculation must be done before investing in current assets.
Current assets should properly be valued and disposed of from time to time once they become
non profitable. Currents assets must be used in times of liquidity problems and times of
insolvency. Liquidity describes the degree to which an asset or security can be quickly bought
or sold in the market without affecting the asset’s price. Market liquidity refers to the extent to
which a market, such as a country’s stock market or a city’s real estate market, allows assets to
be bought and sold at stable prices.
Dividend Decisions: Dividend decision refers to the policy that the management formulates in
regard to earnings for distribution as dividends among shareholders. Dividend decision
determines the division of earnings between payments to shareholders and retained earnings .
The Dividend Decision, in corporate finance, is a decision made by the directors of a company
about the amount and timing of any cash payments made to the company’s stockholders. The
Dividend Decision is an important part of the present day corporate world. The Dividend
decision is an important one for the firm as it may influence its capital structure and stock
price. In addition, the Dividend decision may determine the amount of taxation that
stockholders pay.
ELEMENTS OF STRATEGIC FINANCIAL MANAGEMENT
A company will apply strategic financial management throughout. It often involves designing the
elements which will increase the financial resources of the company and using them efficiently.
The organization needs to be creative since there is no standard approach for strategic
management. Every company will have to be creative and devise their strategy. It also devices its
elements that reflect their needs and their vision and mission. However, the following are a few
of the common elements of strategic financial management:
1. Planning
Define your financial objectives clearly and precisely. Identify the available as well as potential
resources which will be helpful in your financial management. Write a specific business plan.
2. Budgeting
The company should form a budget that will function with proper financial efficiency and
should have minimum waste. Point Out the areas which have the most expenditure and exceed
the budget. Ensure that enough liquidity is present to cover the operating payments without
using any external sources. Uncover the specific areas in the company which should invest to
achieve the goal more efficiently.
3. Management and assessment of risk
The financial manager should identify, properly analyze, and take steps to mitigate the
uncertainty in the decisions related to investment. You have to revisit all the potential for
financial exposure and examine the capital expenditures as well as the workplace policies.
Also, the risk metrics, such as standard deviation and value at risk strategies, should be
assessed.
4. Establishment of ongoing procedures
Collect and analyze the data and make the financial decisions that are consistent with your
vision and mission. Variants if any should be tracked and analyzed, which is the difference
between actual and budgeted results. Identify the problems and take appropriate actions to
rectify them.

Scope of Strategic Financial Management

1. Make Restitution: When deciding on this factor for investment selections, time is of the
utmost importance. The choice is made on the basis of the investment’s ability to be
repaid as quickly as possible. In simple terms, pay back is the amount of time it takes for
cash flows generated by a project to repay the initial investment to a company’s
account. On the basis of this criterion, projects with a shorter payback period will be
given preference.

2. Urgency: In many corporate units, business companies, and government organizations,

the usage of the word “urgency” is used as a criterion for the selection of investment
projects. The following criteria are used to determine the urgency of a project:

• Offers adequate reason for conducting the project;

• It maximizes revenues;
• Contributes immediately to the achievement of the project’s objectives;
Despite the fact that urgency as a criterion lacks disadvantages of financial management due to
the fact that it is not quantifiable, it does give an ordinal ranking scale for the selection of
projects on a preferred per-exemption basis, which is extremely useful.

3. Return on Investment (ROI): In addition to profit margins, scope of strategic financial

management gives additional choice criterion based on accounting records or
 anticipated financial statements to assess profitability as a proportion of capital used on
a yearly basis. The rate of return is calculated by comparing the outcomes of two
alternative techniques of processing revenue in the study, each of which produces a
different conclusion. Following subtraction of depreciation charges, the average income
generated by the investment is calculated in the first scenario. In the second scenario,
the initial cost is used as the denominator, rather than the average investment, to
calculate the return on investment. Using this formula, we can get the basic annual rate
of return. This is in accordance with the “bigger and better” concept. If you choose to
use this criteria, you may compare it to either the average investment in the year
chosen for research or just to the original cost.

4. Benefit-to-Cost Ratio without Discount: It is defined as the relationship between the

total benefits and the whole cost of the project. Benefits are accepted on their face
worth. The ratio may be expressed as “gross” or “net.” When it is computed with
benefits and without subtracting depreciation, it is referred to as “net.”

5. Benefit-to-Cost Ratio with Discount: Because it is based on the present value of future
benefits and expenses, this ratio is more trustworthy than the previous one. It can also
be expressed as gross or net, as in the previous example. It takes into consideration all
revenues, regardless of when they are earned, and so complies with the “larger and
better” concept to some extent. Because of the inclusion of the discount factor, early
receipts are given a higher weight than late receipts in the accounting system. This ratio
meets the needs of both principles and serves as a useful criterion for decision-making
in a variety of situations. Along with this scope of financial management will also give
you good knowledge on the topic.

6. Present Value (PV): The Present Value Method is a method of calculating the present
value of a financial asset under scope of strategic financial management. Because it
indicates that the value of money is continually dropping, this notion is valuable as a
choice criteria because it reveals that a rupee obtained now is worth more than a rupee
received at the end of a year. There are even limitations of financial statements analysis
which you should be aware of it.

7. Internal Rate of Return (IRR): It is a commonly utilized factor in the evaluation of

investment opportunities. IRR is a measure of how profitable a business is. It takes into
consideration the element of interest. It is referred to as marginal efficiency of capital or
the rate of return above the cost of capital. In this section, it specifies the rate of
discount that will be used to balance the present value of net benefits with the cost of
the project. This approach meets both of these requirements in equal measure. It is
possible to explore in detail the factors that are employed in scope of strategic financial
management, with specific reference to the capital structure of a business unit, in this
section.

8. Capital structure of a corporate unit consists of two essential parameters: equity, which
represents the ownership capital of the firm, and debt, which reflects the interest of
debenture holders in the company’s assets. Tax savings, ease of sale, the advantage of
leverage, lower cost of capital, no dilution of equity and probable loss of control, the
inflationary trend of rising interest rates, lower cost of flotation and services, the logical
 consolidation and funding of short-term indebtedness through a bond issue, and the
improvement in financial ratios are the factors that contribute to the inclusion of debt in
a company’s capital structure.

Shareholder Value Creation

Shareholders’ value can be defined as the value that shareholders of a company receive as
dividends and stock price appreciation as a result of better decision-making by the
management that ultimately results in a company’s growth in sales and profit. The higher the
profits earned, the higher shall be the dividends offered to the equity holders.
In highly volatile and complicated marketplace, it is import to create shareholder value which
can lead to firm's success. Shareholder value is a business concept, and referred as shareholder
value maximization or as the shareholder value model, which suggests that the ultimate
measure of a company's achievement is the extent to which it augments shareholders. It
became popular during the 1980s. This notion is used in several ways:

• To refer to the market capitalization of a company.

• To refer to the model that the main goal for a company is to increase the wealth of its
shareholders (owners) by paying dividends and/or causing the stock price to increase.

Principally, the idea that shareholders' money should be used to earn a higher return than they
could earn themselves by investing in other assets having the same amount of risk. The term,
shareholder value was originated by Alfred Rappaport in 1986. Creating value for shareholders
is now extensively recognized corporate objective. The interest in value creation has been
motivated by several developments.

1. Capital markets are becoming progressively global. Investors can willingly shift
investments to higher yielding, often foreign, opportunities.
2. Institutional investors, which usually were inactive investors, have begun exerting
influence on corporate managements to create value for shareholders.
3. Corporate governance is instable, with owners now demanding liability from corporate
managers. Manifestations of the increased assertiveness of shareholders include the
need for executives to justify their compensation levels, and well-publicized lists of
underperforming companies and overpaid officials.
4. Business press is highlighting shareholder value creation in performance rating
exercises.
5. More focus is to link top management compensation to shareholder returns.

Value Creation
A company must always prioritize the interests of its shareholders and must take every possible
measure for shareholders’ value creation. There are various principles that a company must
necessarily follow for shareholder’s value creation. The first principle that a company must
abide by is that it must not manage its earnings or, in other words, it must not participate in the
earnings expectations game.

This is high because if a company focuses too much on maximizing its earnings, it tends to
compromise its value, and this can even destroy its ability to make operating decisions. The
company must take strategic decisions that can help the same in maximizing the expected
value, even if it comes at the cost of slight losses or a lowered rate of earnings in the near
future. The company must make acquisitions that can help it by maximizing the expected value.
The company must move forward with assets that add value to the business.

How to Create Shareholder Value

1. Revenue Growth
a. Increasing Sales Volume:
A company would want to retain its current customers and keep them away from competitors
to maintain its market share. It should also attract new customers through referrals from
existing customers, marketing and promotions, new product and service offerings, and
new revenue streams.
b. Raising Sales Price:
A company may increase current product prices as a one-time strategy or gradual price
increases throughout several months, quarters, or years to achieve revenue growth. It can also
offer new products with advanced qualities and features and price them at higher ranges.
2. Operating Margin
Besides maximizing sales, a business must identify feasible approaches to cost reductions
leading to optimal operating margins. While a company should strive to reduce all its
expenses, COGS (Cost of Goods Sold) and SG&A (Selling, General, and Administrative)
expenses are usually the largest categories that need to be efficiently managed and
minimized.
a. Cost of Goods Sold (COGS)
When a company builds a good relationship with its suppliers, it can possibly negotiate with
suppliers to reduce material prices or receive discounts on large orders. It may also form a
long-term agreement with the suppliers to secure its material source and pricing.
b. Selling, General, and Administrative (SG&A) Expenses
SG&A is usually one of the largest expenses in a company. Therefore, being able to
minimize them will help the company achieve an optimal operating margin. The company
should tightly control its marketing budget when planning for next year’s spending. It should
also carefully manage its payroll and overhead expenses by evaluating them periodically and
cutting down on unnecessary labor and other costs.
3. Capital Efficiency
Capital efficiency is the ratio between dollar expenses incurred by a company and dollars that
are spent to make a product or service, which can be referred to as ROCE (Return on Capital
Employed) or the ratio between EBIT (Earnings Before Interest and Tax) over Capital
Employed. Capital efficiency reflects how efficiently a company is deploying its cash in its
operations.
a. Property, Plant, and Equipment (PP&E)
To achieve high capital efficiency, a company would first want to achieve a high return on
assets (ROA), which measures the company’s net income generated by its total assets. More
the fixed assets increase in the value of assets
b. Inventory
Inventory is often a major component of a company’s total assets, and a company would
always want to increase its inventory turnover, which equals net sales divided by average
inventory. A higher inventory turnover ratio means that more revenues are generated given
the amount of inventory. Increasing inventory turnover also reduces holding costs, consisting
of storage space rent, utilities, theft, and other expenses. It can be achieved by effective
inventory management, which involves constant monitoring and controlling of inventory
orders, stocks, returns, or obsolete items in the warehouse.
c. Shareholder Value in Practice
There are many factors that influence shareholder value and it can be very difficult to
accurately attribute the causes in its rise or fall.
Managers of businesses constantly speak of “generating shareholder value” but it is often
more of a soundbite than an actual practice. Due to a host of complications, including
executive compensation incentives and principal-agent issues, the primacy of shareholder
value can sometimes be called into question.
Advantages

• Shareholder’s value can bring a lot of benefits to an organization. It offers the

management of a company with a long-term view and based on this. The management
can design strategic decisions.
• It allows the company to emphasize more on the future and its clients and consumers
and offers a universal approach as well.
Disadvantages

• Shareholder’s value can even have implications on the well-being of an organization. A

lot of organizations tend to stress only maximizing their profits for the sake of
maximizing shareholder’s value. This is why the organizations take up rigorous and
devastating measures that compromise business ethics but fetch profits.
• The organization might choose to compromise on quality, increasing the prices of the
products unnecessarily, etc. However, these profits earned are just short-lived. Such
organizations might end up losing customer’s trust and may earn bad goodwill in the
eyes of society and its industry too. This increases the risk for the organization and may
even result in bankruptcy for the same.
Importance
In the modern era, it is extremely vital to keep the value added to the investors of the company
at the very forefront of the company’s decision-making styles. Shareholders value creation
somehow dictates the market sentiment about the company, and thereby, the market value of
the company in the open market.

The importance of creating shareholders’ value is strongly linked with the efficiency of capital
markets. It also encourages a legitimate process of evaluation of the performance of the
management. The shareholder’s value is also important for organizations in developing an
environment of trust that will keep the shareholders glued with the organization and will also
help in leveraging capital investments in the company.

Framework shareholders value creation

Creating shareholder value is a fundamental goal for any business. Shareholder value is the
return on investment that shareholders receive from holding a company's stock. Frameworks
for shareholder value creation typically involve strategies and actions that increase a company's
profitability, efficiency, and overall market value. Here are some key components and
frameworks commonly considered for creating shareholder value:

1. Profitability Improvement:
Revenue Growth: Increase sales and market share through product innovation, market
expansion, and effective marketing strategies.
Cost Reduction: Improve operational efficiency and reduce costs to enhance profit
margins.
2. Capital Efficiency:
Asset Utilization: Optimize the use of assets to generate higher returns on invested
capital.
Working Capital Management: Efficiently manage working capital to reduce the need for
external financing.
3. Risk Management:
Strategic Risk Assessment: Evaluate and manage risks associated with the business
environment, competition, and industry trends.
Financial Risk Management: Mitigate financial risks related to currency fluctuations,
interest rates, and commodity prices.
4. Corporate Governance:
Transparent Reporting: Ensure accurate and transparent financial reporting to build
trust with shareholders and the broader market.
Effective Board Oversight: Establish a strong board of directors to provide strategic
guidance and oversight.
5. Dividend Policy:
Dividend Payouts: Adopt a balanced dividend policy that provides returns to
shareholders while retaining enough earnings for growth and investment.
6. Strategic Investments:
Capital Allocation: Prioritize and allocate capital to projects that offer the highest
potential return on investment.
Mergers and Acquisitions: Pursue strategic acquisitions or partnerships that
complement the company's core competencies and contribute to long-term growth.
7. Innovation and Adaptation:
Research and Development: Invest in research and development to stay competitive
and innovative within the industry.
Adaptability: Be responsive to changing market dynamics and customer preferences.
8. Communication with Shareholders:
Effective Communication: Regularly communicate the company's strategy, performance,
and future plans to shareholders.
Share Buybacks: Consider share repurchases as a means to return value to shareholders.
9. Environmental, Social, and Governance (ESG) Considerations:
Sustainability Practices: Implement sustainable and socially responsible business
practices to attract investors with a focus on ESG criteria.
10. Long-Term Perspective:
Strategic Vision: Develop and communicate a clear long-term vision for the company to
align stakeholders and attract long-term investors.
Challenges in strategic financial management

1. TECHNOLOGY IS REPLACING SOME OF THE TRADITIONAL ACCOUNTING FUNCTIONS

2. THE NEED TO LEARN NEW SKILLS
3. CYBERSECURITY CONCERNS
4. IMPORTANCE OF DEVELOPING SOFT SKILLS
5. THE NEED TO PROVIDE REAL-TIME DATA

1.TECHNOLOGY IS REPLACING SOME OF THE TRADITIONAL ACCOUNTING FUNCTIONS

Automation and AI are gradually becoming capable of performing some of the duties
traditionally performed by accountants, such as compiling transactions and using them to
produce tax returns and financial statements. Moreover, automation will take over the routine,
recurring tasks such as tax calculations and payroll processing, freeing up the time of finance
professionals for more value-adding work such as financial planning, analysis, and risk
management.

2.THE NEED TO LEARN NEW SKILLS

As technology reduces demand for some of the traditional accounting skills such as
bookkeeping, processing transactions and maintaining extensive records, other skills such as
those related to analysis, forecasting, and financial strategy are likely to grow in importance
with time. Professionals who wish to be competitive in the future job market need to learn
these skills.

A degree in finance can be useful for this purpose as it covers all these areas. It can help you
develop the technical and analytical skills needed to assess large amounts of financial data and
use it for forecasting and decision-making. Finance experts are also able to offer financial
advice to help their clients manage liquidity, control costs, and make sound investment
decisions. Make sure to read more about the challenges and opportunities that a finance
degree offers before deciding if it’s the right option for you. It could be helpful to know about
the average salaries of enrolled agent vs CPA.

3.CYBERSECURITY CONCERNS
Accounting information is one of the hottest targets for hackers. Whether it is bank account
details, credit card information, or passwords to accounting systems, all these are high-value
pieces of information about a business for a hacker.

With the rapid increase in cybersecurity attacks, it is the responsibility of accounting and
finance professionals to have all the necessary measures in place to protect financial data. They
must ensure the accounting software is regularly updated as these updates often involve
protection against the latest security risks. Access to financial data should get restricted to only
those who need it to perform their job duties. Additionally, cloud-based systems are

considered more secure than traditional software, so businesses should consider whether the
switch to the cloud can be a suitable option for them.
4.IMPORTANCE OF DEVELOPING SOFT SKILLS
With time, it has become increasingly important for finance professionals to develop soft skills.
From being a separate function to playing a central part in managing the organization, the roles
and responsibilities of the finance department have changed. The gap that previously existed
between finance and other departments is gradually closing. Therefore, if finance professionals
wish to liaise with other departments effectively, they need to work on building their
communication and interpersonal skills. Doing so will allow them to connect with other
stakeholders of the business and gain their trust.

Unfortunately, soft skills are something that most finance professionals lack. Their nature of
work has always been such that their interactions were limited. But if the finance professionals
of today wish to become successful business partners, they need the training to develop these
skills.

5. THE NEED TO PROVIDE REAL-TIME DATA

Real-time data has become all the rage nowadays. As the accounting systems become
computerized, many finance departments tend to provide the management with information
that is up-to-date and reflects the exact position of the company at any point in time.

Although real-time data is something every finance department aims for, it is not as easy to
achieve as it looks. The main reason being that many finance departments still rely on
spreadsheets for their day-to-day tasks, even if this means duplication of work. Worksheets are
just more convenient, and it will take some time before finance professionals can commit to
replacing them entirely.

Definition of risk
Risk refers to the probability or likelihood of an adverse event or outcome occurring, as well as
the potential impact or harm that it may have. It can be seen as the uncertainty associated with
an action or decision, where the outcome is not entirely predictable and may be influenced by
various factors beyond one’s control.
Meaning of risk
Risk refers to the possibility or likelihood of harm, loss, or other negative consequences
resulting from an action, decision, event, or situation. It involves uncertainty about the
outcome and the potential for adverse consequences.
Risk can arise in various contexts, such as in finance, health, safety, security, and the
environment. It can be quantified and measured, and often requires careful assessment and
management to minimize its potential impact.
Risk is the potential that a chosen action or activity (including the choice of inaction) will lead
to a loss (an undesirable outcome). The notion implies that a choice having an influence on the
outcome exists (or existed). Potential losses themselves may also be called "Risks". Almost any
human endeavor carries some risk, but some are much more risky than others

Risk means a probability or threat of damage, injury, liability, loss, or other negative occurrence
that is caused by external or internal vulnerabilities, and that may be neutralized through
preemptive action.
Risk means the fair of danger. Risk is always concern the capital loss. It is a measurable
uncertainty.
According to Weston & Brigham, “Risk is the chance that some unfavorable event will occur.”
According to J. C. Van Horne, “Risk is defined as the variability of possible return from a
project.”
Another definition is that risks are future problems that can be avoided or mitigated, rather
than current ones that must be immediately addressed.

In other word, Risks are future problems that can be avoided or mitigated, rather than current
ones that must be immediately addressed.
Financial risk is often defined as the unexpected variability or volatility of returns and thus
includes both potential worse-than-expected as well as better-than-expected returns.
The related term "hazard" is used to mean something that could cause harm.

Nature or features of risk

Risk can be defined as the probability of harm occurring and the potential severity of that
harm. The nature or features of risk can vary depending on the context, but generally include:

1. Probability: Risk is often expressed as a probability or likelihood of harm occurring. The

higher the probability, the greater the risk.
2. Severity: The severity of harm that may occur if a risk eventuates can range from minor
to catastrophic.
3. Uncertainty: Risk involves uncertainty, as it is impossible to predict with absolute
certainty whether harm will occur.
4. Variability: Risks can vary in their likelihood and severity, and may change over time.
5. Consequence: Risks can have consequences that are financial, reputational,
environmental, or social, among others.
6. Financial Risk: This refers to the risk associated with financial investments or
transactions. Examples include market risk, credit risk, and liquidity risk.
7. Operational Risk: This refers to the risk of loss resulting from inadequate or failed
internal processes, people, or systems. Examples include employee errors, system
failures, and fraud.
8. Strategic Risk: This refers to the risk associated with a company’s strategic decisions and
actions. Examples include entering new markets, mergers and acquisitions, and changes
in the competitive landscape.
9. Reputational Risk: This refers to the risk of damage to a company’s reputation or brand.
Examples include product recalls, negative publicity, and customer complaints.
10. Political Risk: This refers to the risk associated with political instability or government
intervention. Examples include changes in regulations, nationalization of assets, and
expropriation.
11. Environmental Risk: This refers to the risk associated with environmental factors such as
natural disasters, pollution, and climate change.
12. Legal Risk: This refers to the risk of legal action resulting from non-compliance with laws
and regulations. Examples include lawsuits, fines, and penalties.

Differences between risk and uncertainty

Risk and uncertainty are both terms used in decision-making, but they represent different
concepts. Risk is the possibility of loss or harm, while uncertainty refers to a lack of knowledge
or information about a situation. The key differences between risk and uncertainty are:
1. Probability: Risk involves a known probability of a particular outcome occurring, while
uncertainty refers to a situation where the probability of outcomes is not known.
 2. Information: Risk can be measured and managed with available information, while
uncertainty arises when there is a lack of information or knowledge about a situation.
3. Control: Risks can often be controlled or mitigated through planning and taking
preventative measures, while uncertainty is often beyond our control.
4. Consequences: Risks have known consequences, while uncertainty can lead to
unexpected consequences.
5. Decision-making: Risk can be factored into decision-making by weighing the probability
of outcomes against potential costs and benefits, while uncertainty requires more
subjective judgment and guesswork.

Types of Risk
Broadly speaking, there are two main categories of risk: systematic and unsystematic.
Systematic risk is the market uncertainty of an investment, meaning that it represents external
factors that impact all (or many) companies in an industry or group. Unsystematic risk
represents the asset-specific uncertainties that can affect the performance of an investment.
Below is a list of the most important types of risk for a financial analyst to consider when
evaluating investment opportunities:

#1 – Operational Risk
Operational risks
can be defined as the risks of loss arising from improper implementation of processes, external
issues (weather problems, government regulations, political and environmental pressures, and
so on), etc. Operational risks can be better understood as a type of risk due to inefficiencies in
business operations carried out by an organization. Examples of operational risks are
insufficient resources, failure in resolving conflicts, etc.

#2 – Budget Risk
Budget risk can be defined as a risk that arises from an improper estimation of a budget
allocated to a particular project or process. Budget risk is also regarded as cost risk, and the
implications of such a risk are delay in the completion of a specific project, premature handover
of the project, failure to deliver the quality project or compromise in the quality of the project
in comparison to what was committed to the client, etc.

#3 – Schedule Risk
When the release or completion of the project is not assessed and addressed correctly, the
schedule risk takes place. Such a risk can impact a project and might even be the reason behind
the failure of the same and, thus, can result in losses for the company.

#4 – Technical Environment Risk

Technical environment risk can be regarded as the risk concerning the environment in which
both the customers and the clients operate. This risk can take place due to the testing
environment, regular fluctuations in production, etc.

#5 – Business Risk
Business risks
can occur due to the unavailability of a purchase order, contracts in the initial stage of a
particular project, delay in the attainment of inputs from clients and customers, etc.
#6 – Programmatic Risk
These are the risks that are not within the control of a program or outside the purview of the
operational limits. Changes in product strategy or government regulations are examples of
programmatic risks.

#7 – Information Security Risk

Information security risks are concerned with the breach of the confidentiality of a company’s
or clients’ sensitive data. The violation of such data can be a huge risk for an organization, and it
might not just cause financial losses but also result in loss of goodwill
.

#8 – Technology Risk
Technology risks occur due to sudden or complete change concerning technology or even the
installation of new technology.

#9 – Supplier Risk
Supplier risks take place in a scenario where there is third-party supplier interference in the
development of a particular project owing to his association in the same.

#10 – Resource Risk

Resource risk occurs due to improper management of a company’s resources such as its staff,
budget, etc.

#11 – Infrastructure Risk

Infrastructure risk takes place as a result of inefficient planning concerning infrastructure or
resources, and that is why it is always essential to have appropriate planning of infrastructure
so that the project does not get impacted.

#12 – Technical and Architectural Risk

Technical and architectural risk are such types of risk that fail the overall functioning and
performance of an organization. These risks arise out of the failure of software and hardware
tools and equipment that are taken into use in a particular project.

#13 – Quality and Process Risk

Quality and process risk occurs due to improper application of customizing a process and hiring
of staff to the process that is not well trained and as a result of which the outcome of a process
gets compromised.

#14 – Project Planning

Project planning risks are such risks that arise out of lack of proper planning concerning a
project. This lack of project planning can cost the project to sink and fail to meet the
expectations of the clients as well.

#15 – Project Organization

Project organization is another risk associated with the improper organization of a particular
project. This lack of project organizing can cost the project to sink and fail to meet the
expectations of the clients as well.
Important
1. policy or entering into a forward contract.
2. Transferred to another party, who is willing to take risk, say by buying an insurance
3. Reduced, by having good internal controls.
4. Avoided, by not entering into risky businesses.
5. Retained, to either avoid the cost of trying to reduce risk or in anticipation of higher
6. profits by taking on more risk.
7. Shared, by following a middle path between retaining and transferring risk

Sources of Financial Risks

1. Interest Rate Risk:
Interest rate risk is the variability in a security’s return resulting from changes in the
level of interest rates. Other things being equal, security prices move inversely to
interest rates. This risk affects bondholders more directly than equity investors.

2. Market Risk:
Market risk refers to the variability of returns due to fluctuations in the securities
market. All securities are exposed to market risk but equity shares get the most
affected. This risk includes a wide range of factors exogenous to securities themselves
like depressions, wars, politics, etc.

3. Inflation Risk:
With rise in inflation there is reduction of purchasing power, hence this is also referred
to as purchasing power risk and affects all securities. This risk is also directly related to
interest rate risk, as interest rates go up with inflation.

4. Business Risk:
This refers to the risk of doing business in a particular industry or environment and it
gets transferred to the investors who invest in the business or company.

5. Financial Risk:
Financial risk arises when companies resort to financial leverage or the use of debt
financing. The more the company resorts to debt financing, the greater is the financial
risk.

6. Liquidity Risk:
This risk is associated with the secondary market in which the particular security is
traded. A security which can be bought or sold quickly without significant price
concession is considered liquid. The greater the uncertainty about the time element and
the price concession, the greater the liquidity risk. Securities which have ready markets
like treasury bills have lesser liquidity risk.
Risk Analysis
Risk analysis is the procedure of analyzing and recognizing any kind of risk that could adversely
affect the primary business objective or any critical projects that are about to take place in an
organization in regards to avoiding or to take necessary initiatives to reduce such risks in the
organization.
Risk analysis is a process of assessing and evaluating potential risks and their impact on an
organization, project, or decision-making. It involves identifying, analyzing, and prioritizing risks
to make informed decisions on how to mitigate or manage them effectively.
Risk Analysis is a systematic way to fully assess risks, to get transparency into complexity and to
address uncertainties or knowledge gaps. It facilitates making Risk Management decisions and
communicating about risk. It comprises three components:
Risk Assessment
Risk Management
Risk Communication
Statistical techniques for Risk Analysis

Risk-adjusted discount rate

Risk adjusted discount rate approach is an estimation of the present value of cash for
high risk investments. A very common example of risky investment is the real estate.
Risk adjusted discount rate is representing required periodical returns by Investors for
pulling funds to the specific property. It is generally calculated as a sum of risk free rate
and risk premium.)
Certainity equivalent approach
The certainty equivalent approach is a guaranteed return that someone would accept
rather than taking a chance on a higher but uncertain return.
The certainty equivalent approach explicitly recognizes risk but the procedure for
reducing the forecasts of cash flows is implicit and is likely to be inconsistent from one
investment to another. Further this method suffers from many dangers in a large
enterprise.
Sensitivity analysis
Sensitivity analysis helps a business estimate what will happen to the project if the
assumptions and estimates turn out to be unreliable. Sensitivity analysis involves
changing the assumptions or estimates in a calculation to see the impact on the
project’sfinances. In this way, it prepares the business’s managers in case the project
doesn’t generate the expected results, so they can better analyze the project before
making an investment.

Probability distribution
The concept of probability is for incorporating risk in evaluating capital budgeting
proposals. The probability distribution of cash flows over time provides valuable
information about the expected value of return and the dispersion of the probability
 distribution of possible returns which helps in taking accept-reject decision of the
investment decision.

Standard deviation
Standard deviation is defined as the Square root of the mean of the Squares of
deviationsfrom the mean.
The concept of standard deviation was introduced by Karl Pearson’s in 1893. It is the
most important and widely used measures of studying dispersion. It overcomes the
defects from the earlier methods.
Standard deviation is “the square root of the arithmetic mean of the square deviations
of various values from their arithmetic mean.
Standard deviation is the absolute measures of dispersion of a distribution. The
greaterstandard deviation indicates more variations and less uniformity. The smaller
standarddeviation indicates less variations and more consistency of a series.
Coefficient of variation

Variance (2) is a measure of the dispersion of a set of data points around their mean value. In
other words, variance is a mathematical expectation of the average squared deviations from
themean. It is computed by finding the probability-weighted average of squared deviations
from the expected value. Variance measures the variability from an average (volatility).
Volatility isa measure of risk, so this statistic can help determine the risk an investor might
take on when purchasing a specific security
DECISION TREE

Decision tree is a decision support tool that uses a tree-like graph or model of decisions and
their possible consequences, including chance event outcomes, resource costs, and utility. It
isone way to display an algorithm.

Meaning

Decision Tree is a graphical representation of various decisions, techniques and sequence in

events of decision problem.

Decision Trees for Sequential Investment Decisions

A decision tree is a flowchart-like structure in which the internal node represents a test on an
attribute, each branch represents the outcome of the test and each leaf node represents a
class label (decision taken after computing all attributes) A present decision depends upon
future events, and the alternatives of a whole sequence of decisions in future are affected by
the present decision as future events. Thus, the consequence of each decision is influenced
by theoutcome of a chance event. At the time of taking decisions, the outcome of the chance
event isnot known, but a probability distribution can be assigned to it. A decision tree is a
graphic display of the relationship between a present decision and future events, future
decisions, and their consequences. The sequence of events is mapped out over time in a
format similar to thebranches of a tree. While constructing and using a decision tree, some
important steps should be considered.

I. Define investments: The investment proposal should be defined. Marketing production

or any other department may sponsor the proposal. It may be either to enter a new
market or to produce a new product.
II. Identify decision alternatives: The decision alternatives should be clearly identified
For example if a company is thinking of building a plant to produce a new product, it
may construct a large plant, a medium-sized plan, or a small plant initially and expand
it later on or construct no plant. Each alternative will have different consequences.
III. Draw a decision tree: The decision tree should be graphed indicating the decision
points, chance even, and other data. The relevant data such as the projected can flows,
probability distribution, and the expected present value; should be located on the
decision tree branches.
 IV. Analyze data: The result should be analyzed and the best alternative should be selected

Decision Tree Analysis

A decision tree is a graphic presentation of the present decision with future events anddecisions. The
sequence of events is shown in a format that resembles the branches of a tree

Risk Analysis

Risk analysis refers to the uncertainty of forecasted future cash flow streams, variance of portfolio/stock
returns, and statistical analysis to determine the probability of a project’s success or failure and possible
future economic states. Risk analysts often work in tandem withforecasting professionals to minimize
future negative unforeseen effects

CORPORATE VALUATION

In the field of finance, corporate valuation is the process of determining the value of a business entity.
It is an important aspect of corporate finance, used for a wide variety of purposes. Valuation is essential
for mergers and acquisitions, where a sound decision has to be made whether and at what price to
acquire a company. The value of a company could be different for sellers and buyers, so valuation is
integral part of the negotiation process. It is also crucial for the effective management of a company, for
identifying its value-generating units, and formulating strategies for growth. Initial public offerings,
portfolio management, and tax assessment are also areas that involve a lot of corporate valuation.

There are different valuation methodologies, yielding different results and used in different situations.
The three main methods are discounted cash flow analysis (DCF), trading multiples, and precedent
transactions. An experienced financial analyst knows how to use these methods in combinations in order
to reach conclusive valuations.
HOW TO VALUATE A BUSINESS

1. Book Value
One of the most straightforward methods of valuing a company is to calculate its book value using
information from its balance sheet. Due to the simplicity of this method, however, it’s notably unreliable.
To calculate book value, start by subtracting the company’s liabilities from its assets to determine
owners’ equity. Then exclude any intangible assets. The figure you’re left with represents the value of
any tangible assets the company owns.

2. Discounted Cash Flows

Another method of valuing a company is with discounted cash flows. This technique is highlighted in the
Leading with Finance as the gold standard of valuation.
Discounted cash flow analysis is the process of estimating the value of a company or investment based
on the money, or cash flows, it’s expected to generate in the future. Discounted cash flow analysis
calculates the present value of future cash flows based on the discount rate and time period of analysis.
Discounted Cash Flow = Terminal Cash Flow / (1 + Cost of Capital) # of Years in the Future
The benefit of discounted cash flow analysis is that it reflects a company’s ability to generate liquid
assets. However, the challenge of this type of valuation is that its accuracy relies on the terminal value,
which can vary depending on the assumptions you make about future growth and discount rates.

3. Market Capitalization
Market capitalization is one of the simplest measures of a publicly traded company's value. It’s calculated
by multiplying the total number of shares by the current share price.
Market Capitalization = Share Price x Total Number of Shares
One of the shortcomings of market capitalization is that it only accounts for the value of equity, while
most companies are financed by a combination of debt and equity.
In this case, debt represents investments by banks or bond investors in the future of the company; these
liabilities are paid back with interest over time. Equity represents shareholders who own stock in the
company and hold a claim to future profits.
4. Enterprise Value
The enterprise value is calculated by combining a company's debt and equity and then subtracting the
amount of cash not used to fund business operations.
Enterprise Value = Debt + Equity - Cash
5. EBITDA
When examining earnings, financial analysts don't like to look at the raw net income profitability of a
company. It’s often manipulated in a lot of ways by the conventions of accounting, and some can even
distort the true picture.
To start with, the tax policies of a country seem like a distraction from the actual success of a company.
They can vary across countries or time, even if nothing actually changes in the company’s operational
capabilities. Second, net income subtracts interest payments to debt holders, which can make
organizations look more or less successful based solely on their capital structures. Given these
considerations, both are added back to arrive at EBIT (Earnings Before Interest and Taxes), or “operating
earnings.”
In normal accounting, if a company purchases equipment or a building, it doesn't record that transaction
all at once. The business instead charges itself an expense called depreciation over time. Amortization is
the same thing as depreciation but for things like patents and intellectual property. In both instances,
no actual money is spent on the expense.
In some ways, depreciation and amortization can make the earnings of a rapidly growing company look
worse than a declining one. Behemoth brands, like Amazon and Tesla, are more susceptible to this
distortion since they own several warehouses and factories that depreciate in value over time.

6. Present Value of a Growing Perpetuity Formula

One way to think about these ratios is as part of the growing perpetuity equation. A growing perpetuity
is a kind of financial instrument that pays out a certain amount of money each year—which also grows
annually. Imagine a stipend for retirement that needs to grow every year to match inflation. The growing
perpetuity equation enables you to find out today’s value for that sort of financial instrument.
The value of a growing perpetuity is calculated by dividing cash flow by the cost of capital minus the
growth rate.
Value of a Growing Perpetuity = Cash Flow / (Cost of Capital - Growth Rate)
So, if someone planning to retire wanted to receive $30,000 annually, forever, with a discount rate of 10
percent and an annual growth rate of two percent to cover expected inflation, they would need
$375,000—the present value of that arrangement.

Need for Performing a Valuation

Valuation is an important exercise since it can help identify mispriced securities or determine what
projects a company should invest. Some of the main reasons for performing a valuation are listed below.

1. Buying or selling a business

Buyers and sellers will normally have a difference in the value of a business. Both parties would benefit
from a valuation when making their ultimate decision on whether to buy or sell and at what price.

2. Strategic planning
A company should only invest in projects that increase its net present value. Therefore, any investment
decision is essentially a mini-valuation based on the likelihood of future profitability and value creation.

3. Capital financing
An objective valuation may be useful when negotiating with banks or any other potential investors for
funding. Documentation of a company’s worth, and its ability to generate cash flow, enhances credibility
to lenders and equity investors.

4. Securities investing
Investing in a security, such as a stock or a bond, is essentially a bet that the current market price of the
security is not reflective of its intrinsic value. A valuation is necessary in determining that intrinsic value.

Problems With Business Valuations

Challenge: Lack of Access to Reliable Data
Obtaining accurate and up-to-date information can be a major roadblock. Incomplete or unreliable data
can hinder the valuation process, leading to skewed results.
Solution: Expand Your Data Sources
Diversify your data sources by utilizing financial statements, industry reports, market research, and
qualitative information from management interviews. Leverage technology tools and platforms that
provide comprehensive and reliable data, ensuring your valuation is based on the most accurate
information available.
2⃣ Challenge: Complex Financial Modeling
Constructing intricate financial models can be daunting and time-consuming. The complexity involved in
forecasting future cash flows, determining discount rates, and selecting appropriate valuation methods
can be overwhelming.
Solution: Leverage Valuation Software
Harness the power of valuation software to streamline your financial modeling process. These tools offer
pre-built templates, automated calculations, and advanced features that simplify complex tasks. By
using such software, you can save time and enhance accuracy while performing valuations.
3⃣ Challenge: Subjectivity and Bias
Valuation is often influenced by personal opinions, biases, and subjective judgments. This can lead to
discrepancies and variations in the final valuation figures, affecting the credibility of your analysis.
Solution: Implement Objective Standards
To mitigate subjectivity, establish a robust framework that follows objective valuation standards and
guidelines. Rely on established methodologies such as market approaches, income approaches, and
asset-based approaches. Document your assumptions, methodologies, and rationale to ensure
transparency and defendability in your valuation.
4⃣ Challenge: Changing Regulatory Landscape
Keeping up with evolving regulations and compliance requirements is crucial for accurate valuations.
Changes in accounting standards, tax laws, and industry regulations can significantly impact valuation
methodologies and outcomes.
Solution: Stay Abreast of Regulatory Updates
Stay informed about the latest developments in accounting standards, tax regulations, and industry-
specific guidelines. Engage in continuous professional development through training, workshops, and
industry conferences to ensure your valuation practices align with the current regulatory landscape.
5⃣ Challenge: Communicating Complex Findings
Effectively conveying valuation results to stakeholders who may not be familiar with valuation concepts
can be challenging. Presenting complex findings in a clear and concise manner is essential to facilitate
informed decision-making.
Solution: Enhance Communication Skills
Sharpen your communication skills to bridge the gap between technical valuation concepts and non-
experts. Simplify complex terminology, use visual aids such as charts and graphs, and focus on the key
insights that matter to your audience. Invest time in developing persuasive narratives that highlight the
value drivers and potential risks associated with the valuation.

Approaches to Valuation
Business Valuation is the process of determining the financial value of a business. Business valuation is
performed because it is helpful information during litigation; it helps develop your business' exit strategy
for buying and selling a business, acquiring funding, and strategic planning.
Valuation methods refer to the different approaches and methods set in place to determine the value
of your business or asset for financial reporting. There are four approaches to valuation. These are-
Cash approach
Market Approach
Income Approach
Brand Valuation Approach
Cash approach method of valuation
The cost approach method is used to calculate the value of properties that are of special use, generate
little income, and are seldom marketed. These properties include- places of worship, schools, libraries,
and hospitals. The cost approach method of valuation is used during insurance appraisals because the
homeowner's policy and claims only ensure the value of the improvements made on the land. Therefore,
the value of land is subtracted from the total value of the property. Asset-intensive companies and
holding companies use the cost approach to valuation. The book value method of the cost approach is
used to evaluate non-operational/ surplus assets.

Market Approach
The market approach is one of the most commonly used business valuation methods. As the name
suggests, this valuation method uses relevant financial information of identical or comparable
companies to estimate the value of the subject business, its intangible assets, security, and business
ownership interest.
In this valuation method, the subject business's value is ascertained by comparing the business with a
similar business in size and operations. This valuation method utilizes price-related indicators like sales
to determine appraisal value. This valuation method is also known as the relative valuation method.
The market approach to business valuation is categorized into four distinct methods- Market price
Method, Comparable Companies Method, Comparable Transaction Method, and EV to Revenue
Multiples Method

Income Approach
The income approach to business valuation is one of the three main valuation methods. The income
approach to valuation calculates the present value of future income that a business will generate by
analyzing variables like revenue, taxes, and expenses.
The income approach to valuation is based on the assumption that an investor would like to know the
economic benefits an investment will provide them in the future. The income approach to business
valuation assesses the risks associated with investing in a business and the money it is likely to earn.
The income approach to business valuation is a valuation method that calculates future earnings,
operating profits, costs, net profit, and how much cash the business will be generating in the future that
can be disposed of.
The income approach to business valuation is categorized into three distinct valuation methods: the
Discounted cash flow method, Price Earning Capacity Method, and the Option Pricing Method.

Brand Valuation
Brand valuation refers to the process of calculating the value of a brand or how much someone is willing
to pay for it. Brand valuation is a valuation method through which a brand can ascertain the value of its
tangible and intangible assets. Customer perception, financial performance, brand equity, and similar
metrics are used to determine the estimated value of a brand from this valuation method.
Brand valuation is important in the case of mergers and acquisitions for better financing, to ascertain
their return on brand investment, and for budgeting allocations. Brand valuation is categorized into
three methods- Relief from Royalty Method, Multi-period Excess Earning Method, and With or Without
Method

Comparable Companies Method

Comparable companies method or comparable analysis or guideline public company method is a
technique under the market approach of business valuation. In this method of valuation, appraisers
analyze the ratios of a similar company to derive the value of the subject company.

One of the biggest drawbacks of this valuation method is that the appraiser has to find the right
comparable companies. Companies are chosen based on similar characteristics like industry
classification, size of the company, revenue, growth rate, profitability, geography, assets, and the
number of employees.

Although it is hard to find an identical company match, financial metrics like valuation ratios can be
derived from similar enterprises. However, adjustments in the metrics must be made on account of
dissimilarities with the subject company for more accurate results.

In this valuation method, the following financial information is analyzed- EBDITA (earnings before
interest, taxes, depreciation, and amortization), EPS (earnings per share), gross profit, net debt, and
revenue.

Discounted cash flow method

The discounted cash flow method is the go-to valuation method for most appraisers. The discounted
cash flow method of business valuation calculates the value of a business by discounting all future cash
flows from the present value using a discount rate.

In other words, the discounted cash flow method of valuation determines the value of a business by
estimating future cash flows and then discounting the cash flows back to the present date of valuation.

Although it shows the investors how much earnings their investments will make in the future, its biggest
drawback is that it is hard to predict the future. Another drawback of the discounted cash flow is that it
relies solely on projections and assumptions, resulting in mistakes in projecting.

Adjusted Book Value

Adjusted book value is the measure of a company's valuation after liabilities—including off-balance
sheet liabilities—and assets adjusted to reflect true fair market value. The potential downside of using
adjusted book value is that a business could be worth more than its stated assets and liabilities because
it fails to value intangible assets, account for discounts, or factors in contingent liabilities. However, it’s
not often accepted as an accurate picture of a profitable company's operating value; however, it can be
a way of capturing potential equity available in a firm.

Valuation of IP
The valuation of an asset integrates the legality of that property with the economic concept of its value.
Now, one of the prerequisites of (commercial) valuation is context. An asset’s value cannot be
determined without context; it is always in reference to place, time, and other relevant variables. With
regard to tangible assets there exist well-developed methods for the same.

IP applications and stakeholders constitute diverse categories, with each field having its own legal and
regulatory framework. Even within one category, such as patents, there’s heterogeneity with regards to
their nature, purpose, time frame, etc. The terms and conditions of intellectual property exchanges vary
widely. Moreover, there are no established markets for the exchange of intellectual property assets.
Further, the details of intellectual property exchanges, especially prices, are rarely available to the
public. Therefore, IP valuation requires a more specialized approach, more advanced methods. These
methods consume substantial amounts of time and capital; thus, their continued growth indicates some
very real, economic benefits arising out of valuation, a realization that has dawned only gradually.