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Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 1
© 2013 International Society of Business Analysts all rights reserved. No part of this work may be reproduced or used in any form or by any means, graphic,
electronic, or mechanical, including photocopying, recording or information storage and retrieval systems without prior written permission from the International
Society of Business Analysts. Copyright violations will be prosecuted to the fullest extent of the law.
Basic Accounting
Entities
Accounting Methods
Financial Definitions
Business Valuation Basics
Business Valuation Definitions
Ratios
Business Valuation Concepts
Revenue Ruling – 59/60
Valuation Principles
Business entitles need accounting reports for three essential purposes: 1. Tax returns are prepared to determine amount of tax owed.
2. Accounting reports keep managers informed about what is going on
and financial position of company.
3. External financial statements go to those persons outside a business who need to stay informed.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 2
Financial Statements consist of three basic reports:
1. Balance Sheet – Shows the financial status of a business on a certain date
2. Income Statement – Summarizes financial activities during a specified period of time
3. Cash Flow Statement – sources and uses cash
A Statement of the financial status of the business on a certain date Assets - Economic resources owned by business
Current – cash, accounts receivable, inventory
Fixed – land, buildings, equipment
Other assets – prepaid expenses
Liabilities – What the business owes
Current – accounts payable; payroll taxes payable (1 yr. or less)
Other – income taxes
Long term – notes payable (more than 1 year)
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 3
Formulas
Total assets = Liabilities + Owner’s Equity
Assets – Liabilities = Owner’s Equity
Owner’s Equity = Net Worth
Basic Accounting Function
Debits = Credits
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 4
Definition: Sources and uses of cash
In and Out Flows of Cash:
From operations
From financing activities
From investing activities
Varies from company
to company
May not be debt free
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 5
Summarizes the financial activity for a specified time period
Sales Revenue – Income generated from sales of products or services to customers
– Less the Cost of Goods Sold; direct costs
Equals Gross Profit
– Less the Overhead Expense
Equals Net Income Before Tax
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 6
• Basic guidelines and methods to measure profit
• Value Assets and Liabilities
• Disclosure of information in external statements
Basic Accounting Principle What It Means in Relationship to a Financial Statement
Reliability: Accountants are required to work with and present
valid information. Accountants ensure that their information is
valid by only working with numbers that can be verified
objectively. Objective verification might include: bills of sale,
receipts, processed checks, bank statements and inventory
counts. To ensure reliability, GAAP calls for unbiased
estimation, using approved scientific methods performed by an
independently qualified individual.
Historical Cost: Historical cost refers to the price at which
something was bought or what the buyer paid. It's called
"historical cost" because the amount is fixed in history. GAAP
requires accountants to record all transactions at historical cost.
Historical cost is used because value changes day-to-day and
depending on circumstances. For example; an organization
buys a copy machine for $250; after a year of use, the machine
may only be worth $200, but it's still recoded on the balance
sheet as $250 worth of equipment. The historical cost principle
is the same in both appreciation and depreciation; the
accountant logs the estimated adjustments on the original
number while still listing its historical cost.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 7
Revenue Recognition
Revenue is not recognized or recorded until it's
physically earned. Future income and projected
income are not considered earned income and
cannot be officially recorded as earned. To be
considered "earned," revenue must come from an
affirmed sale of a good or service, it must be a
recordable amount, and the buyer must have paid
or be expected to pay (as in the case of credit).
Matching
Accountants must match generated revenue with the resources that helped to generate
that revenue. For example, a landlord would match rent income with the apartment she
earned it from, and a grocery store owner would match the expense of buying a can of
soup with the revenue generated from selling the can of soup. The resources used to
generate income are called expenses, not costs. It's important to note that a resource
bought remains a cost until it's used up in the pursuit of revenue generation, at which point
the "cost" becomes an "expense."
Modification
The Federal Accounting Standards Advisory Board (FASAB) establishes and
alters GAAP to conform to fairness and changing times. There are certain
circumstances where an individual accountant or company may modify
GAAP to suit their needs. Such occasions might include times when the
information is truly inconsequential or times when complying with GAAP
would result in an unnecessarily disastrous outcome.
Basis
The GAAP and IRC (Internal Revenue Code) methodologies for
calculating the cost basis of a newly acquired asset are identical. Included
in the basis is the purchase price of the asset plus costs incurred to
transport the asset, sales taxes and installation costs.
Depreciation
The amount of depreciation and the periods it can be taken are
significantly different for financial accounting and tax purposes. Pursuant
to GAAP, the useful life of the asset and the depreciation method can be
chosen by the asset's owner. However, the IRC provides the useful life for
each category of assets and limits discretion in choosing a depreciation
method.
Gain and Loss
The amount of gain or loss resulting from the sale of an asset is
calculated the same for GAAP and tax purposes. The basis is reduced by
the aggregate amount of depreciation taken and subtracted from the sales
price. The amount of gain or loss will be different under GAAP than for tax
purposes because of differences in depreciation rules.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 8
T
• Compilations – take what
you give us
• Reviewed – look at
details of what’s given
• Audited – we will look at
everything
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 9
• Sole Proprietorship
• Partnership
• Limited Liability Corporations (LLC)
• Corporations
Default option
One owner
Unlimited liability
Extension of the owner
Schedule C
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 10
Avoids double taxation
Liability differences
• General partners have unlimited liability; have management responsibility
• Limited partners subject to limited liability; ownership rights to profits but may not participate in management of the business
Advantages
• Limited liability-corporation
• Pass through taxation-partnership
• Flexible management structure
Disadvantages
• More paperwork
Regular “C” corporations
Subchapter “S” corporations
• One class of stock
• Fewer than 100 shareholders
• “Pass-through” of tax liability
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 11
Taxable-entity C corporation
• Corporate income tax paid
• Stockholders pay a second tax on distribution of dividends making double taxation
Pass – through entities
• No corporate income tax
• Stockholders pick up proportionate share of income on personal returns (K-1)
• Section 338 (H)(10)
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 12
Cash Basis
Accrual Basis
Modified Accrual
Bookkeeping vs. Accounting
It’s A Matter Of Time
Income and expenses are recognized when the business actually received the income or paid the expense
Accrual Based statements recognize assets, liabilities, income and expenses when earned or owed, not just when paid and received as do cash basis statements.
When analyzing, it is always preferable to recast statements to an accrual basis.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 13
“The Real World” – a hybrid or
combination
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 14
Accounting – Prepares reports
based on the information
accumulated by the bookkeeping
process
Bookkeeping – Act of recording all of
the information regarding the
transactions and financial activities of
the business
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 15
Accounts – Basic category of information
Chart of Accounts – Index of
accounts General Ledger – Reflects all
accounts and current balances
Source documents – Supporting documentation
Accrual basis accounting – Income/expenses recognized
when the business acquires the right to receive the income
or the obligation to pay the expenses
Aging Accounts Receivable – Analysis of unpaid
receivables
Balance Sheet – A snapshot of the financial status on a
certain date
Blue-Sky – That portion of value that cannot be supported through the application of established valuation methodology
Cash Basis Accounting – Income and expenses are recognized when the income is received or expenses are paid
Cash Flow – Net income plus non-cash charges and extraordinary items
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 16
Net Cash Flow – Net income plus non-cash charges and extraordinary items less amounts needed for capital expenditures, plus/minus net change in working capital, plus/minus changes in debt
Cash Flow Statement - Sources and uses of cash
Cost of Goods – Expenses applicable to
the materials and labor incorporated
directly in the goods or services delivered
DBA “Doing Business As” – Assumed name
Depreciation/Amortization – Loss in value which cannot be corrected with normal repairs; expense of original cost to be written off against income over recovery period
Discretionary Earnings – Adjusted earnings before taxes, interest expense, non-operating and nonrecurring expenses. Depreciation and non-cash charges prior to deducting officer’s salary
Earnings
EBT – Earning before tax
EBIT – Earnings before interest & taxes
EBITDA – Earnings before interest, taxes,
depreciation and amortization
FIFO – First in, First out; Inventory valuation method
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 17
Goodwill – Intangible assets as a result of name, reputation, customer patronage, location, products, etc.
Gross Profit – net Sales after the subtraction of Cost of Goods Sold
Income – Earnings or Profit Income Statement – Summarizes
the financial activities of a business during a specified period of time; Companion document of the Balance Sheet; typically issued together
LIFO – Last In, First Out; most recent unit of an item of inventory purchased is the first unit sold from inventory
M & A – Mergers and Acquisitions
Net Profit – Total revenues less all deductible items
Net Worth – Total assets minus total liabilities as shown on balance sheet
Ownership – Asset vs. stock ownership
Perquisites – Perks; special benefits
received because of position
Reserve for Replacement – Additions
to a fund sufficient to meet the estimated
cost of replacement of fixed assets
Working Capital – Excess of the value
of the current assets over the value of
the current liabilities
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 18
Approaches vs. Methods
• Methods are under Approaches
• Three (3) Approaches – “AIM”
Asset Approach
Income Approach
Market Approach
---
- - - - - - - - - - - - - - - - - - - - - - - - - - - - -
Asset Approach
Adjusted Net
Asset Method
Excess Earnings
Method
Liquidation
Method
- - - - - - - - - - - - - - - - - - - - - - - - - - - - -
Business Valuation
Income Approach
Capitalization of
Earnings Method
Discounted
Future Earnings
Method
Procedures / Techniques
Methodologies
- - - - - - - - - - - - - - - - - - - - - - - - - - - - -
Market Approach
Merger &
Acquisition Method
Guideline Public
Company Method
Direct Market Data
Method
- - - - - -
- - - - - -
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 19
Asset Approach – Value of
assets net of liabilities
•Adjusted Net Asset Method • Net Tangible Asset Method
• Adjusted Book Value Method
•Excess Earnings Method • Intangibles only
•Liquidation Method
Income Approach – Converts
anticipated economic benefits into a
present value
• Capitalization of Earnings Method
Single Period Capitalization
• Discounted Future Earnings Method
Multiple Period Discounting
Discounted Cash Flow Method
Market Approach – Compares the
subject to similar businesses that have
sold
• Merger & Acquisition Method
• Guideline Public Company
Method
• Direct Market Data Method
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 20
Asset (Asset-Based) Approach - a general way of
determining a value indication of a business,
business ownership interest, or security using one or
more methods based on the value of the assets net
of liabilities.
Book Value – Capitalized cost less
depreciation/amortization
Capitalization - a conversion of a single period of
economic benefits into value.
Common Size Statements – statements
expressing each line as a percentage of the
total
Cost Approach - a general way of
determining a value indication of an
individual asset by quantifying the amount
of money required to replace the future
service capability of that asset.
Cost of Capital - the expected rate of
return that the market requires in order to
attract funds to a particular investment.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 21
Discount for Lack of Control - an amount or percentage deducted from the pro
rata share of value of 100% of an equity interest in a business to reflect the
absence of some or all of the powers of control.
Discount for Lack of Marketability - an amount or percentage deducted from
the value of an ownership interest to reflect the relative absence of marketability.
Discount Rate - a rate of return used to
convert a future monetary sum into present
value.
Discounted Cash Flow Method – a method
within the income approach whereby the
present value of future expected net cash
flows is calculated using a discount rate.
Discounted Future Earnings Method – a
method within the income approach whereby
the present value of future expected economic
benefits is calculated using a discount rate.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 22
Effective Date - see Valuation Date.
Valuation Date – the specific point in time as of which the
valuator's opinion of value applies (also referred to as "Effective
Date" or "Appraisal Date").
Equity – the owner’s interest in property after deduction of all
liabilities.
Equity Net Cash Flows - those cash flows available to pay out to
equity holders (in the form of dividends) after funding operations of
the business enterprise, making necessary capital investments, and
increasing or decreasing debt financing.
Excess Earnings - that amount of anticipated economic
benefits that exceeds an appropriate rate of return on
the value of a selected asset base (often net tangible
assets) used to generate those anticipated economic
benefits.
Excess Earnings Method - a specific way of
determining a value indication of a business, business
ownership interest, or security determined as the sum of
a) the value of the assets derived by capitalizing excess
earnings and b) the value of the selected asset
hypothetical willing and able seller, acting at arm’s length
in an open and unrestricted market, when neither is
under compulsion to buy or sell and when both have
reasonable knowledge of the relevant facts.
Fair Market Value-the price, expressed in terms of cash
equivalents, at which property would change hands
between a hypothetical willing and able buyer and a
hypothetical willing and able seller, acting at arm’s length
in an open and unrestricted market, when neither is
under compulsion to buy or sell and when both have
reasonable knowledge of the relevant facts.
Goodwill - that intangible asset arising as a result of name, reputation,
customer loyalty, location, products, and similar factors not separately
identified.
Income (Income -Based) Approach - a general way of determining a value
indication of a business, business ownership interest, security, or intangible
asset using one or more methods that convert anticipated economic benefits
into a present single amount.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 23
Invested Capital - the sum of equity and debt
in a business enterprise. Debt is typically; a) all
interest bearing debt or b) long-term interest-
bearing debt. When the term is used, it should
be supplemented by a specific definition in the
given valuation context.
Investment Value - the value to a particular
investor based on individual investment
requirements and expectations.
Market (Market-Based) Approach - a general
way of determining a value indication of a
business, business ownership interest,
security, or intangible asset by using one or
more methods that compare the subject to
similar businesses, business ownership
interests, securities, or intangible assets that
have been sold.
Merger and Acquisition Method – a method
within the market approach whereby pricing
multiples are derived from transactions of
significant interests in companies engaged in
the same or similar lines of business.
Normalized Financial
Statements – financial
statements adjusted for non-
operating assets and liabilities
and/or for nonrecurring,
noneconomic, or other unusual
items to eliminate anomalies
and/or facilitate comparisons.
Risk-Free Rate – the rate of return available in the market on an investment
free of default risk.
Standard of Value – the identification of the type of value being used in a
specific engagement; e.g. fair market value, fair value, investment value.
Weighted Average Cost of Capital (WACC) – the cost of capital (discount rate)
determined by the weighted average, at market value, of the cost of all financing
sources in the business enterprise's capital structure.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 24
Current Ratio – Current assets/current liabilities
Quick Ratio – Cash and equivalents
plus trade receivables (net)/current
liabilities
Cost of Sales/Payables Ratio – Cost
of sales/payables
Days Inventory Ratio – Cost of sales
inventory ratio/365
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 25
Debt/Equity Ratio –
Total Liabilities / Shareholder
equity
Return on Equity –
Net Income/Shareholder Equity
(measures earnings on
investment in company)
Discount Rate vs Cap Rate
Build-Up Model
Time Value of Money Calculation
Difference Between Discount & Premium
Changes in Working Capital
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 26
Capitalization Rate (Cap Rate) –
Converts a single forecast income stream into
a value
Key – single period
Present value of an investment based upon a
certain amount of on-going available earnings
Discount Rate –
Measurement of risk of receiving a varied income
stream over a number of years
Rate of return used to convert a future monetary
sum into a present value
Rate of return demanded by investors for risks
associated with a particular investment
REMEMBER – Discount rates and Cap Rates are NOT the same
D-G=C
Discount Rate minus Long Term Growth rate will equal Cap Rate
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 27
Build-Up Model
• Cost of Capital
Risk Free Rate (T Bills)
Equity Risk Premium
Small Company Risk Premium
Industry Risk Premium
Specific Company Risk Premium
Time Value of Money – Calculation
Concept - $1 available today is
worth more than $1 in the future due
to its potential earnings capacity.
Today’s dollar can be invested and
earn interest
Present Value Table – Use the
required rate of return (discount rate)
by dividing one plus the rate into the
future value
Time Value of Money – Calculation
• 25% discount rate
Period 1 1/1.25 = .80
Period 2 .80/1.25 = .64
Period 3 .64/1.25 = .51
Net Cash Flow
Period 1 $401,948 x .80 = $321,558
Period 2 $346,173 x .64 = $221,550
Period 3 $425,191 x .51 = $216,847
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 28
Discount – A reduction in value for
some reason
• For Lack of Control
Minority interest
• For Lack of Marketability
Marketable – ability to quickly
convert property to cash (days)
Non-marketable – inability to
convert a business or business
interest into cash within the
described time period of
marketability
The term: “On a closely held
basis” rather than non-
marketable or
MARKETABLE ON A CLOSELY
HELD BASIS
Premiums
• Control premium
• Build up Model; Cost of Capital
Risk Free Rate
Equity Risk Premium
Small Company Risk Premium
Industry Risk Premium
Specific Company Risk Adjustments
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 29
The Eight Factors of RR 59-60
1. The nature of the business and the history of the enterprise from its
inception.
2. The economic outlook in general and the condition and outlook of the
specific industry in particular.
3. The book value of the stock and the financial condition of the business.
4. The earning capacity of the company.
5. The dividend-paying capacity.
6. Whether or not the enterprise has goodwill or other intangible value.
7. Sales of the stock and the size of the block of stock to be valued.
8. The market price of stocks of corporations engaged in the same or a
similar line of business having their stocks actively traded in a free and
open market, either on an exchange or over-the-counter
NEBEDISM
3 Commonly Referred To Valuation Principles…
The “economic principle of
substitution” is based upon the fact that no prudent individual would pay more for an asset than the price required to obtain an equal asset of comparable utility.
The “principle of future benefits” is the fundamental business valuation principle that states – economic value reflects anticipated future benefits.
The “principle of alternatives” states that in any contemplated transaction, each party has alternatives to consummating the transaction.
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 30
Defined as: “The price,
expressed in terms of cash
equivalents, at which
property would change
hands between a
hypothetical willing and able
buyer and a hypothetical
willing and able seller, acting
at arm’s length in an open
and unrestricted market,
when neither is under
compulsion to buy or sell
and when both have
reasonable knowledge of
the relevant facts”.
Defined as: “The value to a particular
investor based on individual
investment requirements and
expectations”.
Defined as: “The value that an investor
considers, on the basis of an evaluation or
available facts, to be the "true" or "real" value that
will become the market value when other
investors reach the same conclusion. When the
term applies to options, it is the difference
between the exercise price or strike price of an
option and the market value of the underlying
security”.
Would you pay $2.1 million for a 1909
Honus Wagner baseball card?
Level 1 BCA – Kick Start Orientation
© 2014 International Society of Business Analysts all rights reserved. 31
© 2013 International Society of Business Analysts all rights reserved. No part of this work may be reproduced or used in any form or by any means, graphic,
electronic, or mechanical, including photocopying, recording or information storage and retrieval systems without prior written permission from the International
Society of Business Analysts. Copyright violations will be prosecuted to the fullest extent of the law.
Level 1: Valuation Essentials
Dates: February 20 - February 23, 2014
Location: Hampton Inn & Suites
Goodyear, AZ
Time: 8:30 - 5:00 (Class Ends At Noon on 2/23)
Level 2: Advanced Techniques
Dates: April 9 - April 13, 2014
Location: Hampton Inn & Suites
Goodyear, AZ
Time: 8:30 - 5:00 (Class Ends At Noon On 4/13)
