Question

There are various methods of analyzing company’s value, describe the warning signals of a cooked book.

Answer 1

1.Various methods of analyzing company’s value

Companies are valued for purposes of take-overs,mergers ,acquisitions or leveraged buy-outs.

Common valuation methods employed normally include comparable company analysis, precedent transactions and DCF analysis

Comparable company analysis is also called trading or peer group multiples is a valuation method under which the current value of the business is compared with peers carrying on similar business & referring their trading multiples like P/E, EV/EBITDA, or such similar ratios.

Precedent transaction analysis is to compare & analyse transactions of businesses that have been sold or acquired in the recent past.But this method is less common , as compared to the above , as it tends to become out-dated rather quickly over time.

DCF /Discounted Cash Flow analysis forecasts the free cash flows over a future period & discounts them back to their present values , using the company's weighted average cost of capital,ie. WACC.This is also called the intrinsic value approach .This is the most accurate of the three approaches to value a business.

2.Warning signals of a cooked book

Books of accounts are cooked up,in other words ,manipulated as per the wishes of the management , the way it wants them to be projected/understood & analysed --by various users of its financial informations .

The users include a wide range of individuals/groups of people like, potential invetsors,existing shareholders,creditors,debtors, government agencies and the like.

All the above mentioned as well as other multiple users must watch for the warning signs that convey that the books,ie, the recorded figures , are likely to have been cooked up.

Some of the warning signs may include:

1.Continuously lesser cash income than that shown as per income statement , making the user alert to the fact that too many fictitious expense might have been booked.

2. Similarly, with revenues , especially when incentives are based on revenues , giving rise to over-booking of revenues , some fictitious, some not at all belonging to the period.

3.Too many reversals of either expense/income ,in the next accounting period beginning immediately after the closure of books ,should lead the user to probe last period's books , particularly, the income statement , for over/under booking of expenses/revenues .

4. Too little or too large a cash balance , as compared to the other periods , or when compared to what is normal for the industry.

Thus,it is for the respective user ,to discern ,analyse & intrepret the recorded values-- by comparing either with peers or within the same company for the prior periods ,or with industry averages -- and probe & satisfy himself-- that the books are not cooked up.