Company valuation plays a major role in corporate finance, investment decisions, and regulatory compliance. Businesses seeking to raise capital, sell shares, or comply with tax regulations must obtain valuation reports to determine their fair market value (FMV), reports are required under various laws, including the Companies Act, 2013, Income Tax Act, 1961, and Foreign Exchange Management Act (FEMA), 1999 as per Reserve Bank of India (RBI) guidelines.
Provisions for Valuation Reports
– Valuation Reports Under the Companies Act, 2013
Under the Companies Act, 2013, valuation reports are mandatory for certain transactions to protect shareholders and ensure transparency. Section 247 of the Act mandates that a Registered Valuer must conduct an independent valuation for the following transactions:
• Private Placement (Section 42): When a company issues shares privately, a valuation report from a Registered Valuer is required to justify the share price.
• Preferential Allotment (Section 62): Companies issuing shares on a preferential basis must obtain a valuation report.
• Mergers & Acquisitions (Sections 230-232): Valuation reports are necessary to determine fair share exchange ratios.
• Employee Stock Option Plans (ESOPs): A valuation report is required to establish the fair market value of ESOPs.
– Valuation Reports Under the Income Tax Act, 1961
The Income Tax Act, 1961 mandates valuation reports in the following cases:
• Section 56(2)(viib) – Issue of Shares at a Premium: If a company issues shares above fair market value (FMV), a Merchant Banker’s valuation report is required.
• Rule 11UA – FMV Calculation: Valuation methods include the Discounted Cash Flow (DCF) and Net Asset Value (NAV) methods, with DCF valuations requiring a Merchant Banker’s certification.
• Capital Gains (Section 50CA, 55A): Valuation is necessary when calculating capital gains on the transfer of unlisted shares.
-Valuation Reports Under FEMA and RBI Regulations
When foreign investors are involved, FEMA and RBI regulations apply. Key requirements include:
• Foreign Direct Investment (FDI) Reporting: Companies receiving FDI must submit valuation reports as per RBI guidelines.
• Form FC-GPR: Required when issuing shares to non-residents, along with a CA’s valuation report.
• Form FC-TRS: Required when transferring shares between residents and non-residents.
• Outbound Investments (ODI): Companies investing abroad must obtain a valuation report to comply with FEMA’s pricing guidelines.
How to Calculate Company Valuation?
There is no single formula for company valuation. Instead, businesses use various approaches based on their financial structure, assets, and industry standards.
-Asset-Based Approach (Net Asset Value – NAV Method)
Formula: NAV = Fair Value of Assets – Liabilities
The Net Asset Value (NAV) method calculates a company’s worth based on its assets and liabilities. This approach is useful for businesses with high tangible assets, such as manufacturing and real estate firms.
-Discounted Cash Flow (DCF) Approach
Formula: DCF = [CF1/(1+r)^1] + [CF2/(1+r)^2] + … + [CFn/(1+r)^n]
Where:
• CF = Cash Flow in respective years
• r = Discount rate (Weighted Average Cost of Capital – WACC)
• n = Number of years
This method estimates the current value of future cash flows, adjusted for time value. It is widely used for startups and high-growth companies.
– Market-Based Approach (Comparable Company Analysis – CCA)
This method determines a company’s valuation by comparing it to similar businesses using financial ratios.
PE Ratio (Price to Earnings Ratio)
Formula: PE Ratio = Stock Price / Earnings Per Share (EPS)
This ratio helps investors determine whether a stock is undervalued or overvalued based on industry benchmarks.
PS Ratio (Price to Sales Ratio)
Formula: PS Ratio = Stock Price / Total Sales
This metric is useful when profits are inconsistent, as it evaluates a company’s worth based on its revenue.
PBV Ratio (Price to Book Value Ratio)
Formula: PBV Ratio = Stock Price / Book Value Per Share
This method is used primarily in banking and asset-heavy industries.
– EBITDA-Based Valuation
Formula: EBITDA to Sales Ratio = EBITDA / Net Sales
Earnings Before Interest, Tax, Depreciation, and Amortisation (EBITDA) provides a clearer picture of a company’s profitability, removing the impact of financial structuring.
Examples of Company Valuation
Example 1: Discounted Cash Flow Method
XYZ Ltd has projected cash flows of ₹300 per share over the next five years, with a discount rate of 10%.
Using the DCF formula, the valuation per share is ₹186.27. If the market price is ₹190, it suggests an overvaluation, making it a potential selling opportunity.
Example 2: PE Ratio Analysis
• The automobile industry average PE ratio is 5.
• ABC Ltd: Share price ₹100, EPS ₹40 → PE Ratio 2.5 (Undervalued)
• XYZ Ltd: Share price ₹80, EPS ₹10 → PE Ratio 8 (Overvalued)
Investors may prefer ABC Ltd as it is undervalued.
Frequently Asked Questions (FAQs)
How do I calculate company valuation from equity?
Formula: Company Valuation = Share Price × Total Outstanding Shares
What is the formula for valuing a company using revenue?
Formula: Company Valuation = Revenue × Industry Multiple
What is Enterprise Value (EV) formula?
Formula: EV = Debt + Equity – Cash
Valuation reports play a key role in regulatory compliance and investment decision-making. Businesses must choose the right valuation method based on industry standards and financial structure. Compliance Calendar LLP assists in obtaining valuation reports to ensure regulatory adherence and smooth financial transactions.
