A financial valuation is an estimate or determination of an item’s value. Companies make valuations on a variety of items, from assets to individual business departments. A number of different models provide information when making a financial valuation. Accountants use market-based estimates for assets, and budgets and discounted cash flows are options for estimates relating to business opportunities or divisions. Either method is acceptable as long as the company is comfortable with the accuracy of valuations.
A market-based financial valuation requires accountants to review assets owned and adjust information on the company’s general ledger. The process begins by obtaining information about what price a willing seller would pay for the asset. A consensus among several buyers leads to the current market for the asset’s valuation. Accountants then make an adjustment and alter the asset’s historical cost to the current market value.
National accounting standards often force companies to make these adjustments on a semifrequent basis to accurately portray their financial positions. The financial valuation process is necessary for assets, investments, and other financial instruments for which the company indicates a value. Adjustments that lead to writing off asset value result in a loss against current net income.
Capital budgets are another tool for making a financial valuation. The capital budget outlines all future expenditures for major assets or other items needed for a company. When a company needs to make several purchases, the value for each item needed comes from a review of current prices from sellers. In some ways, this is similar to a market-based approached to valuing assets. A company’s management team can review the information and look for an alternative asset or request a different financial valuation.
Discounted cash flows are a common corporate finance tool for making a financial valuation. The quantitative steps allow for a more accurate and less subjective approach. Business analysts first estimate future cash flows from a new opportunity or division. They look for inexpensive loans to finance the new project, with the interest rate being the cost of capital. Analysts then discount the cash flows for each year back to current dollar value and compare it to the initial capital outlay for the valuation.
Financial valuation estimates can be highly subjective. A company may need to review several different models until they find one that works best for their operations. Multiple valuation models can provide different outcomes for a single project, allowing a company to have multiple views on the same project.