Valuation of any company might be challenging. Furthermore, it becomes more complex and vital when a distressed company’s business is valued. A corporation that is struggling to meet its debt and other financial commitments is referred to as distressed. Illiquid assets, high fixed expenses, and the sensitivity of revenue to economic downturns may be the causes of this. Due to the rise in borrowing costs, this may result in an operational imbalance.
There are two types of distress- Economic distress and financial distress. Cultural or technical shifts, a general economic downturn, wars, or other geopolitical conflicts are all factors that can lead to economic suffering. Some variables are temporary, while others might result in a long-term shift in the corporate environment. Financial distress frequently follows economic distress. Companies in financial distress cannot fulfill their financial commitments and pay their creditors. Financially distressed companies often exhibit several characteristics, including declining or stagnant revenue, shrinking margins, high leverage, skyrocketing interest costs, capital blockage, high employee and customer attrition rates, shrinking or negative margins, asset divestitures, and a lack of management confidence. Top valuers in India, like Omnifin, can come to the rescue during such scenarios with their best valuation services.
Methods of Business Valuation for Distressed Companies
1. Discounted Cash Flow Valuation:
The sole distinction between the modified and conventional discounted cash flow techniques is how this strategy adjusts for default risk while calculating cash flows. The following is the calculation for expected cash flow:
Expected Cash Flow= SUM(Estimated cash flow in each scenario*Respective scenario’s probability)
The distress adjustment is cumulative and will significantly influence future cash flows. Therefore, it should be taken into consideration.
The issue with the first strategy is that it might not always be possible to compare distressed firms with the appropriate ones.
2. Discounted Cash Flow Valuation Plus Distress Value
This approach uses the following formula to calculate the result:
Value of equity = Distress sale value of equity (Probability of distress) + DCF value of equity on an ongoing concern basis (1 – Probability of distress).
However, the following considerations ought to be made when performing a business valuation:
- The going concern assumption should be used for the business valuation, including traditional valuation.
- Calculate the likelihood of distress at each level.
- Calculate the equity distress sale value.
3. Relative Valuation
This approach is further broken down into two different approaches, which are:
- The first method is to compare the worth of the distressed business to comparable distressed companies or
- Compared to stable companies while accounting for the distress.
The issue with the first strategy is that it might not always be feasible to compare distressed firms with the appropriate ones. For the second strategy, it may be anticipated that the distressed business will probably recover. As a result, an estimate is created based on its potential worth, which is then discounted once more to get a going-concern value. To this value, the possibility of distress and the revenues from a distress sale are then added to determine the ultimate value. Omnifin is a renowned financial counseling firm and a registered valuer in India that provides tailored solutions for the business value of both healthy and distressed companies. It holds a group of experts with knowledge of market trends and skills in examining the company’s situation.