Effect of Provisions on the Valuation of a Company

Jolanta Gadawska

DOI: http://dx.doi.org/10.12775/EQUIL2011.015

Abstract


Provisioning means the evaluation of future costs and losses, the estimation of future liabilities towards one’s surroundings, an increase in equity, as well as the real value of assets.

During asset valuation, the reserve balance may cause a reduction of  the company's value - net assets. This could be a change of a few percentage points.  Non-balance provisions cause a decrease in the value of assets, from which liabilities and reserves will be deducted. The value of the enterprise – through asset evaluation – will be lower by a few percentage points. However, it is  supplementary capital (capital protection) which has the greatest importance in the methods a company uses in the valuation of assets. As research indicates, retained earnings and additional capital make up 30 -59% of owners equity. When using the multiplier method, reserves have a small indirect effect on the amount of dividends, net income decrease, etc. – due to the reducing of the financial result and taxes. The mixed method takes up an important position in the valuation of a company’s goodwill. Therefore, the relevance of provisions in this valuation, will be lower than the during the valuation of assets.

When valuating income reserves do not play a significant role. They are taken into consideration during the adjustment of the financial result, directing it towards cash flow, and for determining the financial outflows in the form of income tax. Provisions may also have a slight influence on the cost of the capital of the enterprise, i.e. a factor discounting cash flow.

Provisions are not cash outflows and therefore, in the most popular income methods, they do not play a significant role. Reserves that are tax-deductible costs may affect the amount of tax burdens and thus indirectly affect the cash flow. The biggest and most direct effect of provisions on the valuation of a company can be observed in the asset methods  as well as in the mixed methods. However, in the reserve multiplier methods affect the value of the multiplier element of a listed company and the value of the company measured the base element.


Keywords


reserves/provisions; methods of valuating company; relations between reserves and the value of company

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