Profitable approach to the valuation of real estate and business. Applying a revenue approach

The income approach is a combination of methods for estimating the value of real estate, property of the organization, the business itself, in which the determination of value is made by converting the economic benefits that are expected in the future. The theoretical basis of this approach is quite convincing. The cost of an investment is the value of future benefits for the current time, which are discounted at a rate of return, which is a reflection of the riskiness of investments.

This is reasonable and suitable for any enterprise operating in the sphere of production and sale of a property object, as well as its business, provided it generates a positive profit. The magnitude of investment risks in the valued business is demonstrated through a discount rate. In the role of such in the economic sense, now is the rate of return that investors require, on invested capital in comparable investment objects at risk level, or it is the rate of return on alternative investment options with comparable risks at the time of valuation.

Features

The application of the income approach in practice proves to be quite a difficult task, since it is necessary to evaluate each important determinant of value - the rate of return and profit. If these methods are used to assess the enterprise, then it is necessary to conduct a thorough analysis of all of their key elements, including the cost, turnover of the company, which directly affect the profit, costs and risks that are created by each individual element.

A profitable approach to business valuation is used quite often. For example, if it is an acquisition or a merger, then this method is used much more often costly or market. Investments of the buyer's capital are now made with the expectation that in the future, net cash flows will be received, which can not be called guaranteed, since they are characterized by certain risks. The income approach allows us to evaluate these key determinants of value, while the market-based approach usually requires a price-earnings ratio or some other similar multiplier of income for a retrospective period, without taking into account the future.

For market multipliers, features such as unreliability are characteristic, as well as the inability to provide the same thoroughness that can be achieved with the use of a revenue approach with a forecast of future profits and discount rates. For example, the "price-earnings ratio", which is applied for the year, does not allow to reflect sufficiently expected changes in future years. Correct use of coefficients provides an opportunity to demonstrate general preferences of investors, they are often quoted by sellers or industry sources.

Using

In the analysis and protection, information concerning the enterprise budget is required, which makes it necessary to carry out changes and improve the financial consequences of the created plan, forecasts and basic proposals. An income-based approach to business valuation allows you to measure all assumptions that relate to whether certain benefits arise from absorption as a result of revenue growth, cost reduction, process improvement, or a reduction in capital expenditure. With the help of this approach, you can measure and discuss everything. In addition, it can help you determine the time of expected benefits, as well as demonstrate the process of reducing the value of the enterprise as the benefits move to a more distant future.

Using the income approach provides an opportunity for buyers and sellers to calculate the fair market value of the enterprise, as well as its investment value for one or more strategic buyers. If this difference is displayed clearly enough, then sellers and buyers can easily determine the benefits of synergy, as well as make informative decisions.

When a profitable approach to business valuation is used, it must be borne in mind that the calculated value consists of the value of all property that is used in the process of immediate activity. Within the framework of the approach used, there are several evaluation methods that are of greatest interest. In particular, such methods of income approach are applicable: capitalization and discounting of cash flows. You can consider them in more detail.

Methods

Using the method of capitalization of cash flows, the total value of the enterprise is detected depending on the cash flows generated by the enterprise's property potential. The cash flows of a business or an enterprise as a whole is the difference between all inflows and outflows of financial assets for a certain billing period. Usually, a period of one year is used for the calculations. The technique is to convert the representative level of the expected flow of money into a present value by dividing the entire amount of the flow by the accepted capitalization rate. In this case, an income stream is appropriate with certain adjustments.

To use the usual method of calculating cash flows, the addition of net profit (calculated after tax) of non-cash expenses is used to determine the amount of absolute cash flow to capitalization. This method of calculation can be considered more simplified in comparison with the calculation of the free flow of money, where, as an addition, the required capital investments and the replenishment needs of capital that is negotiable are taken into account.

Cash flow discounting

This method is basically based only on the expected cash flows generated by the enterprise itself. The characteristic difference is that the valuation is required to calculate the definition of the representative level of the cash flow. This method in developed countries has become most widespread due to the fact that it can be used to take into account all development prospects. The cash flow in general form is equal to the sum of net income and depreciation, provided that the net working capital gain and capital investment are subtracted.

There are the following conditions for using the discounted cash flow method:

• There is reason to believe that future levels of financial flows will differ from current levels, that is, a developing enterprise;
• There is scope for a reasonable estimate of cash flows in the future when using business or commercial real estate;
• The object is under construction, complete or partial;
• The enterprise is a large multifunctional object of commercial value.

The income approach to real estate valuation using the cash flow discounting method is the best, but its use is very labor intensive. There are estimates that can not be made without using this method. Among them is the development of an investment project with its subsequent evaluation.

Advantages of the discounting method

If you practice a profitable approach to the valuation of real estate or business through a discount method, you can identify some of the main advantages. First of all, we are talking about the fact that future profits from business directly take into account only the expected current costs of manufacturing products with subsequent sale, and future investments associated with maintaining and expanding production or trading capacities are reflected in the profit forecast only indirectly through their current Depreciation.

Important points

The valuation of the object by a profitable approach with a lack of profit or loss as an index of investment calculations is carried out with an amendment to the fact that profit serves as an accounting reporting indicator, therefore subject to significant manipulation in the process of work.

Three groups of models are included in the discounting method of cash flows:

• Discounted dividends;
• Residual income;
• Discounted cash flows.

If a profitable approach is used in accordance with the model of discounting dividends as evidence of cash flow, the amount of payments on shares is applied. Despite the fact that the model is widely used in foreign practice to determine and estimate the value of the assets of the enterprise, it has a lot of shortcomings. In models with retained earnings, there is no accounting degree. There is a difference in dividend policies not only for specific enterprises, but also for countries in general. This method can not be used in enterprises that do not have a profit. This model is best suited for calculating the value of minority stakes.

The residual income model

An income-based approach to valuation using the residual approach model assumes that the amount of residual income, that is, the difference between the actual profit and the amount of profit predicted by shareholders at the time of the acquisition of the company or its shares, will be used as an indicator of cash flow. If the value of the enterprise was calculated on the basis of assumptions that correspond to this model, then it will be equal to the amount of the book value with the present value of the expected amount of income remaining after that. Such a model demonstrates a significant sensitivity to the quality of the data that is presented in the financial statements. For Russian conditions, the adequacy of such information is subject to substantial doubt.

Benefits for shareholders

Naturally, the shareholders or shareholders of the company, which has a certain history, as well as the facts of paying dividends, can use the discount model to calculate the value of their own company. The situation is that the shareholders of enterprises in this sector are rarely minority, so for them the most appropriate way will be to use a profitable approach to valuing real estate and business through a model of discounting free cash flow. In this system, free cash flows with discount rates or expected return on invested capital are key. The biggest problem with using this model is the accuracy of the forecast of a free financial flow, as well as an adequate definition of the discount rate.

If the income approach, as defined above, is used, then using the discounted cash flow method as the income expected from the business takes into account the projected financial flows that can be removed from the turnover after the required reinvestment of a part of the monetary profit. As an indicator, cash flows do not depend on the accounting system used at the enterprise, and its depreciation policy. At the same time, it is necessary to take into account any cash flows - inflows and outflows. Evaluation of the financial meaning of discounting the cash is such that as a result of these processes, they are reduced by amounts that would be available to the investor at the time of receipt of the specified cash flow, provided that he invested his money not in this business right now, but in what Is another investment asset of a public nature, for example, a liquid security or a bank deposit.

Additional techniques

The income approach, an example of which was described earlier, has recently been used less and less, now the method of evaluation has become the most common. It is used to evaluate all kinds of assets, and the basis for it is the idea that any asset that shares the basic characteristics of options is allowed to be valued as this option. At the moment, the rejection of the revenue approach is most often carried out in favor of the option pricing model (respectively, the Black-Scholes model).

Such a system, provided it is used, makes it possible to estimate the total cost of the company's own capital or enterprise in the case when it is operating with large losses. This model is designed to further explain why the cost of the company's equity is not zero, even if the value of the entire enterprise falls below the nominal amount of debt. But even with this advantage in mind, it can be noted that the Black-Scholes model for estimating the value of Russian enterprises at the moment is increasingly theoretical. The main problem, because of which this model can not be applied to domestic business, is the lack of some actual data for the model parameters, which are extremely necessary.

conclusions

A profitable approach to the valuation of business and real estate has been used much less often, and this happens for many reasons. In particular, this concerns the shortcomings, because of which there are difficulties in using it in the consumer market. First of all, it should be noted how difficult it is to make forecasts of the future cost of services and products, materials and raw materials, as well as a complex of other cost indicators. At the same time, we can talk about some subjectivity of expert assessments. In addition, the problem is the low disclosure of information on Russian enterprises, and in fact it is necessary for conducting competent calculations and drawing up a model of Black-Scholes. This is due in large part to the low corporate culture of such enterprises.

The overwhelming number of shares, including large packages, is concentrated in the hands of a small number of persons, while the share of minority shareholders and small owners, whose share is very small, is insignificant in the authorized capital. It turns out that many enterprises are simply not interested in disclosing any information. That is why the calculation by the income approach is considerably more complicated with reference to the majority of industries and business in Russia. In other conditions, it works in the best way, demonstrating all its dignity and reliability.