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Finance professionals need to be based on the historic or forecast values
of various financial profit (net income or
competent in the financial EBITDA) or cash flow (free cash flow for
firm (FCFF), free cash flow for equity
reporting and management of (FCFE), or cash from operations)
measures (see the chart “Profit and Cash
intellectual capital. Flow Measures Used in Multiples”).
Valuations based on each of these
financial measures will derive
significantly different valuations. The
multiples will also vary significantly
over time due to factors including
the expertise of a brain surgeon has may be on calculating a number to guide premiums or discounts resulting from
massive value for a hospital but negotiations. However, to manage market conditions, a listing, or a
significantly less to a car dealership. organisational value on an ongoing takeover. The approach seems weak for
Valuations are completed using basis, it will also be necessary to have valuing businesses where most value is
various methods, including component detailed justification as to why the value held in financial capital, but even
valuations, multiples from precedent is at the level it is and how it could worse when it is mainly represented by
transactions or public company change subject to defined actions and intellectual capital. There is no
comparables, and discounted cash flow. under various scenarios. practical insight provided on the
All methods have their strengths and The general principle that intellectual underlying drivers of future financial
weaknesses (see the table, “Weighing Up capital is only of value when it is part of performance, which drive the value
Alternative Valuation Techniques”), and a system rules out component represented in intellectual capital.
the best one to use will often be a matter valuations as a valid method for many This leaves one remaining approach:
of judgement. businesses with a high proportion of discounted cash flow. This uses future
A key consideration will be why the intellectual capital. unlevered free cash flows discounted at
valuation is being completed. In the Precedent transactions and public the business’s WACC to create a business
situation of a sale event, the key focus company comparable multiples may be valuation. It is more complex to prepare
but can provide the most justification
and potentially the most accurate
valuation. Having prepared a base case
Profit and cash flow measures used in multiples valuation, this can then be flexed to
provide scenario modelling. The detail
provided within the valuation can
Net income uncover immensely powerful insights
to guide the realisation of opportunities
to enhance value and avoid value
+ Interest paid destruction. This is subject to two
+ Tax paid critical success factors: determination of
the appropriate discount rate to apply to
+ Depreciation future financial performance values and
the provision of robust long-term
+ Amortisation financial forecasts. Initially, we will look
Earnings before interest, taxes, depreciation, and amortisation (EBITDA) at establishing the appropriate discount
rate to apply to the business or
divisional forecast.
+/- Working capital changes Discount rate
- Capital expenditure Any future values should be discounted
at the appropriate WACC. It may be
Free cash flow for firm (FCFF) necessary to use different WACC values
on various parts of the business to
reflect varying levels of risk on those
+/- Inflows/outflows from debt - Interest paid different areas.
In summary, WACC is derived from
Free cash flow for equity (FCFE) - Tax paid the company’s cost of equity and
Cash from operations after-tax cost of debt weighted in
proportion to the target mix of funding
from equity and debt.
Figure 3: Profit and cash flow measures used in multiples The cost of debt can be identified

30 I FM MAGAZINE I February 2022