Question

Why valuation is considered scientific as well as an art?

(1500words)

Answer 1

Valuation helps in assigning monetary amount to a particular asset, business or any other item. How does one arrive at such value is crucial question. There are formula which can be used to arrive at valuation- this makes us feel that valuation is a science.

However there are many such formula to arrive at valuation of one particular item. Selecting the best formula or best valuation method is an art. Further when such formula is applied, variables might again be taken on subjective basis depending on asset class being valued. This makes valuation more art than science.

Let us understand this using practical example-

One of the famous valuation method for valuing business is DCF ( Discounted cash flow ) valuation method. This method is used more often for valuation of any business. This has a standard formula which is used to arrive at valuation. Thus it is argued to be science.

In this method future cash flow is predicted based on historical cash flow statement and then based on discounted future cash flows valuation is done using formula.

Suppose a new start up business wants to do valuation. DCF valuation method cannot be used here as there is no historical cash flow data due to which future cash flow cannot be ascertained. Now valuation would be done using some other valuation multiple that suits this start up business. This is where subjectivity comes into picture and valuation would be treated as an art.

To conclude we can say that valuation as a method might be science but where to apply and how to apply is an art.