Page 44 - Bankruptcy and Reorganization Services

of the valuation (reorganization value, potential sale, fraudulent conveyance action), it may be appropri-
ate to normalize the financial statements for some elements of the restructuring, but not others.

The footnotes to the financial statements may or may not contain information of a contingent nature that
practitioners need to consider in their business appraisals. Companies that are in distress are more likely
to have off-balance-sheet items with an economic impact on the value of the business.

Step 3: Perform Comparative Financial Analysis

The valuation analyst should perform a comparative financial analysis of the subject company against
the selected guideline companies in order to assess the relative strengths and weaknesses of the subject
company that can affect value considerations. Some of the more important considerations are company
size, historical and projected growth, profitability, asset utilization, liquidity, financial leverage, opera-
tional leverage, and other risk factors.

Step 4: Calculate Guideline Company Multiples

There are two basic categories of market multiples: (a) invested capital multiples and (b) equity multi-
ples. An invested capital multiple shows the total invested capital (both debt and equity) of the company
in the numerator and a parameter reflecting cash flows to both debt and equity holders in the denomina-
tor (for instance, (Debt + Equity)/EBITDA). fn 3 An equity multiple shows equity value in the numerator
and has a denominator reflecting cash flows to only equity holders (for instance, Equity/Net Income). fn 4

Either category can be used for valuing controlling or minority interests. The invested capital method is
preferred for valuing controlling interests because the control buyer is usually interested in the value of
the company irrespective of its capital structure. Furthermore, in the case where the capital structures of
the subject company and guideline companies are significantly different, the valuation analyst may wish
to minimize the effect of the difference by valuing the subject company on an invested capital basis even
when performing a minority interest valuation.

Some practitioners subtract cash and cash equivalents from MVE or MVIC before calculating the multi-
ple on the theory that a buyer will not pay a multiple for cash. fn 5 Others subtract excess cash and equiv-
alents. What is most critical is consistent treatment among the guideline companies and the subject com-
pany. If cash and cash equivalents are subtracted out of the MVE calculation, or some portion thereof,
any return on such assets (such as interest income) must also be subtracted out of the denominator of the
MVE multiple. This adjustment may be especially important for companies in bankruptcy, when cash on

fn 3 Although a financial metric relating to earnings or cash flow is generally the most relevant financial metric to be considered, in
some circumstances, a parameter reflecting the book value of total assets may also be included in the denominator and used in the cal-
culation of invested capital multiples.

fn 4 Although a financial metric relating to earnings or cash flow is generally the most relevant financial metric to be considered, in
some circumstances, a parameter reflecting the book value of equity may also be included in the denominator and used in the calcula-
tion of equity multiples.

fn 5 VS section 100 defines invested capital as "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." While not explicitly defined in VS section 100, enterprise value can be defined
as invested capital net of the valuation date balance of cash and cash equivalents.

42 © 2020 Association of International Certified Professional Accountants