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10 Questions To Help You Evaluate A Valuation Report

05/16/2023 Bryan Setz
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Valuation reports are critical tools used by businesses, investors, and financial professionals to determine the value of an asset, company, or investment opportunity. However, not all valuation reports are created equal. To evaluate the quality and reliability of a valuation report, it’s essential to ask the right questions and scrutinize the expert’s methodology, assumptions, and conclusions. In this article, we’ll discuss ten essential questions that can help you assess the validity and completeness of a valuation report.

1. Did the expert properly define the engagement and purpose of the valuation?
Valuations are conducted for a variety of reasons. The purpose of the engagement should be in alignment with its intended use. For example, a valuation report that was prepared for the purpose of buying out a minority shareholder should not be used to gift a controlling interest in a company. Avoid recycling reports used for other purposes to conduct different transactions. A valuation of a business used to analyze a potential merger with one company does not possess the same facts and circumstances as that of a business in the midst of shareholder litigation.

2. Did the expert consider all three valuation approaches?
The expert should have considered using the (1) asset, (2) income and (3) market approaches to valuing the business. In a conclusion (opinion) of value report, the expert should have disclosed why certain approaches were not used, if that is the case. In a summary engagement, the expert may have focused on only one or two methods. Reliance on a single method leaves room for errors or miscalculations in valuation reports. For example, relying too heavily on market multiples may create a situation where the historical and future operations of the business are not accurately contemplated when comparing to the transactions.

3. Were the company’s financial statements analyzed?
Financial analysis and normalization of a company’s financial statements are key functions of performing valuations. The purpose of making normalization adjustments is so the financial statements more closely reflect the true economic financial position and results of operations on a historical and current basis. An absence of financial analysis in a valuation report is a red flag.

4. Was analysis of the company’s industry and economic environment provided?
In a valuation engagement, the expert is required to analyze the industry and economy as part of determining the subject company’s value. A valuation report should include discussion of the specific industry and broader economic environment as part of the report.

5. Was the scope and timing of the valuation clearly defined?
The “when” and “why” a report was created is essential to understanding the value. A valuation of a business represents its value at a specific point in time. As time progresses and fact patterns change, the valuation of a business will fluctuate. Just as important, understanding the purpose for which a valuation was conducted is crucial to determining whether the value can be considered appropriate by the reader.

6. Are calculations reasonable?
When using cash flows or other income-based methods, an expert selects a discount or capitalization rate to apply to the cash flows to determine the business’s value. If the rates are outside an acceptable range, the value of the business could be significantly high or low. If a rate is being used outside the acceptable range and there is no explanation by the expert as to why, that may indicate that the rates have been manipulated.

7. Are market multiples adjusted?
If the analyst deployed the market approach to calculate value, he or she should have adjusted the comparable companies relative to size, risk, industry, and other factors. The absence of analysis of the market multiples could create an inaccurate valuation.

8. Is the expert independent?
In reports conducted by those with a vested interest in the business, values may be distorted. For example, a key advisor or investment banker holding a financial stake in the outcome of a transaction may deploy adjustments or projections that are too optimistic to drive a higher selling price. As a result, the conflict of interest would deter a user from using this report in a litigation setting.

9. Were assumptions and estimates used in the valuation clearly disclosed?
Any assumptions or estimates used to derive a company’s value should be disclosed in the valuation report. These assumptions are key to understanding where the expert may have had to exercise professional judgment in valuing the company. A reader should be skeptical of a valuation report where it is obvious that assumptions have been made, but not defined, for the reader.

10. Was the report well-written, clear, and easy to understand?
Reports should be organized, spell-checked, and written in a manner that a reader who is not a valuation expert could follow. Reports that use complex industry jargon, confusing or vague explanations, or are disorganized should concern a reader. Additionally, reports that are full of spelling errors, typos or disorganized financial information reduce the credibility of the expert even if the valuation is reasonable.

A healthy level of skepticism

From defining the scope and engagement to analyzing financial statements and broader industry aspects, these questions should assist you in creating a comprehensive framework for evaluating any valuation report. While there are many questions you should ask when reviewing a report, careful examination of this document can assist you in making an informed decision.

For any questions related to this article, please contact Bryan Setz at bsetz@vlcpa.com or 800.887.0437.

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