VALUATION

The Valuation Principle: The foundation of Financial Decision Making

Valuation is the process of estimating something’s worth. Items that are usual10ly valued are
financial assets (e.g. Investments in marketable securities such as stocks, options, business
enterprises or intangible assets such as patent or trademark) or liabilities (e.g. bonds issued by a
company).

In finance, valuations are needed for many reasons such as investment analysis, capital
budgeting, merger and acquisitions, financial reporting, taxable events and in litigation. Since the value
of things fluctuates overtime, valuations are a specific date like the end of the accounting quarter or
year. They may alternately be mark-to-market estimates of the current value of the assets or liabilities
as of this minute or this day for the purpose of managing portfolios and associated financial risk (e.g.
within large financial firms including investment banks and stockbrokers).

Cost-Benefit Analysis

The first step in making financial decision. It is a systematic approach to estimating the
strengths and weaknesses of alternatives. It is used to determine options that provide the best
approach to achieve benefits while preserving savings.

BUSINESS VALUATION
Business valuation is a process and a set of procedures used to estimate the economic value of
an owners interest in a business. Valuation is used by financial market participants to determine the
price they are willing to pay or receive to affect a sale of a business. In addition to estimating the selling
price of a business, the same valuation tools are often used by business appraisers to resolve disputes
related to allocating business purchase price among business assets, establish a formula for estimating
the partners’ ownership interest for buy-sell agreements, and many other business and legal purposes
such as in shareholders and estate contest.

VALUATION APPROACHES

Is the Business Enterprise a

viable entity?

Going Concern Approach Liquidation Approach

Asset Based Approach Asset Based Methodology
Future Based return/Income Approach Orderly vs. Forced
Market Approach

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Income Approach

The income approach relies upon the economic principle of expectations. The value of a
business is based on the expected economic benefit and level of risk associated with the
investment.

The result of a value calculation under the income approach is generally the fair market value of
a controlling, marketable interest in the subject company, since the entire benefit stream of the subject
company is most often valued, and the capitalization and discount rates are derived from statistics
concerning public companies.

However, income valuation methods can also be used to establish the value of a severable
business asset as long as an income stream can be attributed to it.

Under income approach:

a) Capitalization of Earnings method

The Capitalization of Earnings Method is an income-oriented approach. This method is

used to value a business based on the future estimated benefits, normally using some
measure of earnings or cash flows to be generated by the company. These estimated future
benefits are then capitalized using an appropriate capitalization rate. This method assumes
that all of the assets, both tangible and intangible, are indistinguishable parts of the
business and does not attempt to separate their values. In other words, the critical component
to the value of the business is its ability to generate future earnings/cash flows.

It is important that any income or expense items generated from non-operating assets
and liabilities be removed from estimated future benefits prior to applying this method. The fair
market value of net non-operating assets is then added to the value of the business derived
from the capitalization of earnings.

This method is more theoretically sound in valuing a profitable business where the
investor's intent is to provide for a return on investment over and above a reasonable amount of
compensation and future benefit streams or earnings are likely to be level or growing at a
steady rate.

b) Discounted Earnings Method

The Discounted Earnings Method is sometimes referred to as the Discounted Cash Flow
Method, which suggests that the only type of earnings to be valued, using this method, would be some
definition of cash flow, such as operating cash flow, after-tax cash flow or discretionary cash flow. The
Discounted Earnings Method is more general in its definition as to the type of earnings that can be
used.

The Discounted Earnings Method allows several possible definitions of earnings. It does not
limit the definition of earnings only to cash flows. The Discounted Earnings Method is an income-
oriented approach. It is based on the theory that the total value of a business is the present value
of its projected future earnings, plus the present value of the terminal value. This method requires

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that a terminal-value assumption be made. The amounts of projected earnings and the terminal value
are discounted to the present using an appropriate discount rate, rather than a capitalization rate.

Asset-Based Approach

The value of asset-based analysis of a business is equal to the sum of its parts. That is the
theory underlying the asset-based approaches to business valuation. The approach to business
valuation is based on the Principle of substitution that no rations investor will pay more for the business
assets than the cost of procuring assets similar economic utility. In contrast to the income-based
approach, which require valuation professional to make subjective judgments about capitalization
discount rates, the adjusted net book value method is relatively objective.

In considering asset-based approach, the valuation professional must consider whether the
shareholder whose interest is being valued would have any authority to access the value of the assets
directly

Adjusted net book value may be the most relevant standard of value where liquidation is
imminent or ongoing; where the company earnings or cash flow are nominal, negative or worth less
than its assets; or where the net book value is standard in the industry in which the company operates.
The adjusted net book value may also be used as a “sanity check” when compared to the other
methods of valuation, such as the income and market approaches.

Under this method:

a) Book Value Method

This method is based on the financial accounting concept that owners’ equity is
determined by subtracting the book value of a company’s liabilities from the book value of its
assets. While the concept is acceptable to most analysts, most agree that the method has
serious flaws. Under generally accepted accounting principles (GAAP), most assets are
recorded at historical cost minus, when appropriate, accumulated depreciation or cumulative
impairments. These measures were never intended by the accounting profession to reflect the
current values of assets. Similarly, most long-term liabilities (bonds payable, for example) are
recorded at the present value of the liability using rates at the time the liability is established.
Under GAAP, these rates are not adjusted to reflect market changes. Finally, GAAP does not
permit the recognition of numerous and frequently valuable assets such as internally developed
trademarks, trade names, logos, patents and goodwill. Thus, balance sheets prepared under
GAAP make no attempt to either include or correctly measure the value of many assets. Thus,
by definition, owners’ equity will not normally yield a valid measure of the value of the company.
Despite these significant limitations, this approach can frequently be found in buy/sell
agreements. The following information pertains to a company’s balance sheet in Millions of
pesos:

The Value of the business is simply the Difference between the assets and liabilities

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 b) Adjusted Net Asset Method

This method is used to value a business based on the difference between the fair market value of
the business assets and its liabilities. Depending on the particular purpose or circumstances underlying
the valuation, this method sometimes uses the replacement or liquidation value of the company assets
less the liabilities. Under this method the analyst adjusts the book value of the assets to fair market
value (generally measured as replacement or liquidation value) and then reduces the total adjusted
value of assets by the fair market value of all recorded and unrecorded liabilities. Both tangible and
identifiable intangible assets are valued in determining total adjusted net assets. If the analyst will
be relying on other professional valuators for values of certain tangible assets, the analyst should be
aware of the standard of value used for the appraisal. This method can be used to derive a total value
for the business or for component parts of the business.
The Adjusted Net Assets Method is a sound method for estimating the value of a non-operating
business (e.g., holding or investment companies). It is also a good method for estimating the value of a
business that continues to generate losses or which is to be liquidated in the near future.
The Adjusted Net Assets Method, at liquidation value, generally sets a “floor value” for determining
total entity value. In a valuation of a controlling interest where the business is a going concern, there
would have to be a reason why the controlling owner would be willing to take less than the asset value
for the business. This might occur where the assets are under-performing, resulting in a conclusion of
value that is less than the adjusted net assets value but more than the liquidation value. Before
concluding the Adjusted Net Assets Method has established the floor value, the valuator should consider
the potential of overstating the value of assets, existence of non-operating assets, and other omissions
in his/her determination.
The negative aspect to this method is that it does not address the operating earnings of the
business. Therefore, it would be inappropriate to use this method to value intangible assets, such as
patents or copyrights that are typically valued based on some type of operating earnings (e.g., royalties).
However, EXCESS EARNINGS methodology may be utilized in determining values of certain intangibles
such as patents.

Market Approach

The market approach to business valuation is rooted in the economic principle of competition:
that in a free market the supply and demand forces will drive the price of business assets to certain
equilibrium. Buyers would not pay more for the business and the seller would not accept less than the
price of a comparable business enterprise. The market price of the stocks of publicly traded companies
engaged in the same or similar line of business, whose shares are actively traded in a free and open
market can be a valid indicator of value when the transactions in which stocks are traded are
sufficiently similar to permit meaningful comparison.

The difficulty lies in identifying public companies that are sufficiently to the subject company for
this purpose. Also, as a private company, the equity is less liquid than for a public company, its value is
considered to be slightly lower than such a market-based valuation would give.

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MERGING COMPANIES
Forms of Business Combination

Definition: It is a transaction or other event in which an acquirer obtains control of one or more
businesses.

Three forms of business combination used by firms to restructure include:

1. Merger
2. Consolidation
3. Holding Company

Within the past few years, hardly a day passes without a story in the media about a merger, consolidation
or holding companies. The phenomenon has largely been the result of industries needing to become
more competitive in the world markets.

1. Mergers and Acquisitions

MERGER occurs when one corporation takes over all the operations of another business entity
and that other entity is dissolved.

An ACQUISITION is the purchase of one firm by another.

The main difference between a merger and an acquisition lies in the way in which the combination
of the two companies is brought a bout.

In a merger there is usually a process of negotiate ion involved between the two companies prior
to the combination taking place. In an acquisition the negotiation process does not necessarily
take place.

Acquisitions can be:

 Friendly
- In the case of a friendly acquisition the target is willing to be acquired. The target may view
the acquisition as an opportunity to develop into new areas and use the resources offered by
the acquirer. This happens particularly in the case of small successful companies that wish to
develop and expand but are held back by a lack of capital. The smaller company may actively
seek out a larger partner willing to provide the necessary investment. In this scenario the
acquisition is sometimes referred to as a friendly or agreed acquisition.

 Hostile
- Alternatively, the acquisition may be hostile. In this case the target is opposed to the
acquisition. Hostile acquisitions are sometimes referred to as hostile takeovers. In most cases
the acquirer acquires the target by buying its shares. The acquirer buys shares from the
target’s shareholders up to a point where it becomes the owner. Achieving ownership may

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 require purchase of all of the target shares or a majority of them. Different countries have
different laws and regulations on what defines target ownership.

Motives of Merging

Firms merge to fulfill certain objectives. The main goal actually is the maximization of the owner’s
wealth as reflected in the acquirers share price. More specific motives include:

1. Growth or Diversification

Companies desire for rapid growth in size or market share or diversification in the range of
their products. Instead of going through the time-consuming process of internal growth or
diversification the same way, enter into merger with existing firm. Moreover, when a firm
expands by acquiring another firm, it also removes a potential competitor.

2. Synergy
It is the main motivation for a merger wherein two firms work together to produce a
combined value that is greater the sum of their individual values (it is like making 1 + 1 =
3). Thus, lowering combined overhead. It is most obvious when firms merge with other
firms in the same line of business.
3. Fund-raising
Firms combine to enhance their fund-raising ability. One firm may combine with another
that has high liquid assets and low levels of liabilities.
4. Increased Managerial Skill or Technology
A firm having good potential that it finds itself is unable to develop fully because of
deficiencies in certain areas of management or an absence of needed product or product
technology.
5. Tax Considerations

The tax benefit generally stems from the fact that one of the firms has a tax loss carry
over. A company with a tax loss could acquire a profitable company to utilize tax loss.

6. Increased ownership liquidity

The merger of two small firms or of a small and a large firm may provide owners of the
small firm with greater liquidity.

Types of Merger

a. Horizontal Merger – one that combines two companies in the same industry.
Reasons:
1. To meet with more consolidated position at leading, strong third competitor;
2. To cut on overhead or to avail both companies as one of the top talent in each; or
3. To expand scope and increase their shares of the market.

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 Horizontal mergers are carefully scrutinized and regulated by the government for possible
negative effects or restrictions on competition wherein industry members can go into cartels of
monopoly and profits.

Example of Merger:

Another turn-of-the-century drugs merger, Pfizer created the biggest pharmaceutical

company in the US in 2000 when it gobbled up Warner-Lambert with the amount of
$89 Billion. The tie-up began with a hostile takeover bid from Pfizer to thwart Warner-

Lambert’s attempt to hook up with another pharma company, AHP. Pfizer didn’t
want to lose control of the blockbuster statin drug Lipitor, which it had helped
Warner-Lambert bring to market. Post-merger, Lipitor went on to become one of
Pfizer’s best-selling drugs. Horizontal, in the sense that, they both belong to the
pharmaceutical industry.

b. Vertical Merger – Mergers and acquisitions are often used in the pursuit of vertical integration.
In its simplest form, vertical integration is the process of manufacturers merging with suppliers or
retailers. Major production companies obtain supplies of goods and raw materials from a range of
different suppliers. Vertical integration is basically an attempt to reduce the risk associated with
suppliers.
Reasons:
1. Avoidance or reduction of fixed costs;
2. Elimination of costs of searching for prices, contracting, payment collection, advertising
and coordination; and
3. Better planning of inventory.

Example of vertical merger:

Samsung Electronics and Harman International Industries, last

November 14, 2016, announced that they have entered into a definitive
agreement under which Samsung will acquire HARMAN for $8 billion.
HARMAN is the market leader in connected car solutions, with more
than 30 million vehicles currently equipped with its connected car and
audio systems, including embedded infotainment, telematics, connected
safety and security. Since Samsung also manufactures its own cars and
other products that are inclusive of audio system, they just bought their
own producing department of audio systems having acquired their own
retailer or suppliers of such product.

c. Conglomerate Merger – combines two companies that have no related products or markets. The
benefit is the ability to reduce risks by merging firms that have different seasonal or cyclical patterns
of sales earnings. Conglomeration can be a useful approach in spreading business risk across a
range of different areas. As conglomerates grow and expand, however, they run the risk of becoming
unfocused as their senior management team may be unfamiliar with the new products, services and

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 markets that are introduced as unrelated companies are acquired. In effect, the risks increase rather
than decrease.

Example of Conglomerate merger:

The Walt Disney Company moved to create the world's

most powerful media and entertainment company, by
acquiring Capital Cities/ ABC Inc. for $19 billion in
1995. The American Broadcasting Company (ABC) is
an American commercial broadcast television network
and is quite far-off from the products of the Walt Disney Company, which products are in the American
animation industry and diversifying into live-action film production, television, and theme parks.

d. Congeneric Merger/Product Extension Merger – the acquisition of a firm that is in the same general
industry but is neither in the same line of business nor supplier or customer. The benefit is the
resulting ability to use the same sales and distribution channels to reach customers of both
businesses.

Example of Congeneric merger:

BANKING GIANT Citicorp and financial services

titan Travelers Group yesterday stunned financial
markets across the world with plans for the largest-
ever corporate marriage, creating a $155bn (pounds
93m) global powerhouse. While both were in the financial services industry, they had different product
lines; Citicorp focused more on investment banking and financial services while Travelers Group were
insurance-inclined.

2. Consolidation
A consolidation is another type of merger in which an entirely new firm is created. It is
closely related means of “combination”. A consolidation absorbs both the bidder and target
firms to this new firm and the old firm ceases to exist as separate entities, thus in effect
was molded into one large enterprise.

Advantages

1. Both constitute permanent forms of combination which lead to the desirable effect of
management obtaining complete and full control of the business.
2. Same as holding company.

Disadvantages

1. Lack attribute of flexibility

2. It is always necessary to obtain approval and consent of the stockholders of each
corporation involved in either a merger or consolidation, which is not always easy.

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 3. If often times give rise to personnel problems especially with respect to top executives
of several companies, a factor has deferred the formation of mergers and
consolidation in number of instances.

Example:

Perhaps one of the most obvious examples of industry consolidation can be seen in the evolution of
public accounting over the twenty years. In 1986, nine large accounting firms dominated the industry. But
in 1987, Klynveld Main Goerdeler (KMG) merged with Peat Marwick Mitchell to create KPMG Peat
Marwick, reducing the number of top-tier players to the "Big Eight." Then in 1989, Ernst & Whinney
merged with Arthur Young, and Deloitte Haskins & Sells merged with Touche Ross, further consolidating
the industry to the "Big Six." In 1998, the merger of Price Waterhouse and Coopers & Lybrand created
the "Big Five," and the dissolution of Arthur Andersen in 2002 left the "Big Four."

3. Holding Company
It is a corporation whose objective is to obtain or hold enough shares of stocks in other
corporations in order to exercise control over them. In a considerable number of instances,
a holding company is purely a financial enterprise which does not produce any goods
itself. The amazing feature of the holding company is that it brings about maximum
amount of combination and control with a minimum expenditure for stocks.

Advantages

1. It does not require the formal consent of stockholders. Neither would it be necessary to
pay off dissenting minority of cash, as may be evident in the case of merger and
consolidations.
2. It does not result to loss of goodwill with either public or employees.
3. There is no assumption or guaranty of a subsidiary’s liabilities.
4. Any enterprise which has been operating profitable for quite some time may be eased
out from the whole.

Disadvantages

1. Overcapitalization of the holding company may become inevitable.

2. In case where the subsidiaries are only partly owned, the possibility of troubles arising
from minority stockholder is probable.
3. Holding companies are frequently overburdened with the expense of creating and
maintaining separate corporate organizations.

During dull periods, the inability of the subsidiaries to maintain income receipts as much as it used to
prevent the holding companies from receiving any income from them.

Example:

Mahindra & Mahindra, the market leader in utility vehicle and tractors, bought 60
percent stake in Classic Legends (CLPL), a company engaged in manufacturing

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and marketing two-wheelers.

Terms in Business Combination

Acquiree is the business or businesses that the acquirer obtains control of in a business combination.

Acquirer is the entity that obtains control of the acquire

*However, in a business combination in which a variable interest entity is acquired, the primary
beneficiary of that entity always is the acquirer.

Acquisition Date is the date on which the acquirer obtains control of the acquire.

Business is an integrated set of activities and assets that is capable of being conducted and managed for
the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly
to investors or other owners, members, or participants.

Business Combination is a transaction or other event in which an acquirer obtains control of one or more
businesses.

*Transactions sometimes referred to as “true mergers” or “merger of equals” also are business
combinations.

Contingent Consideration usually is an obligation of the acquirer to transfer additional assets or equity
interests to the former owners of an acquire as part of the exchange for control of the acquire if specified
future events occur or conditions are met. However, contingent consideration also may give the acquirer
the right to the return of previously transferred consideration if specified conditions are met.

Control is the power over the investee or the power to govern the financial and operating policies of an
investee as to obtain benefits.

Equity Interests means ownership interests of investor-owned entities and owner, member, or participant
interests of mutual entities.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (FASB Statement No. 157, Fair Value
Measurements, paragraph 5).

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a
business combination that are not individually identified and separately recognized.

An asset is identifiable if it is either:

1. Separable, that is, capable of being separated or divided from the entity and sold, transferred,
licensed, rented, or exchanged, either individually or together with a related contract,
identifiable asset, or liability, regardless of whether the entity intends to do so; or
2. Arises from contractual or other legal rights, regardless of whether those rights are
transferrable or separable from the entity or from other rights and obligations.

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Intangible Asset is an asset (not including a financial asset) that lacks physical substance. As used in this
SFAS No. 141, the term intangible asset excludes goodwill.

Mutual Entity is an entity other than an investor-owned entity that provides dividends, lower costs, or
other economic benefits directly to its owners, members, or participants.

*For example, a mutual insurance company, a credit union, and a cooperative entity are all mutual
entities.

Non-controlling Interest is the equity in a subsidiary not attributable, directly or indirectly to a parent.

Owners include holders of equity interests of investor-owned entities and owners members of, or
participants in, mutual entities.

III. METHODS OF AVOIDING ACQUISITIONS

1. White Knight Strategy
It involves the target firm finding a more suitable acquirer and prompting it t compete with the
initial hostile acquirer to take over the firm

2. Poison Pills
This typically involves the creation of securities that gives their holders certain rights that become
effective when a takeover is attempted.

3. Greenmail
It is a strategy by which the firm repurchases, though private negotiations, a large block of stock
at a premium from one or more shareholders to end a hostile takeover attempt b those shareholders.

4. Leveraged Recapitalization
This is a strategy involving the payment of a large debt financed cash dividends. This strategy
significantly increases the firms financial leverage, thereby deterring the takeover attempt.

5. Golden Parachutes
These are provisions in the employment contracts of key executives that prevail them with sizable
compensation if the firm is taken over.

6. Shark Repellents
These are antitakeover amendments to the corporate charter that constraints the firms ability to
transfer managerial control of the firm as a result of a merger.

7. Employees STOCK Ownership Plans

Help the management to ward off hostile takeover by keeping shares of stock out of the hands of
hostile investors.

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Other Form of Defenses

a. Staggered Board of Directors

It drags out the takeover process by preventing the entire board from having replaced at the same
time. The terms are staggered, so that some members are elected every two years, while others are
elected every four.
b. Supermajority
It is a defense that requires 70 or 80 percent of shareholders to approve of any acquisition.
c. Dual-class stock
This allows company owners to hold onto voting stock, while the company issues stock with little
or no voting rights to the public.
d. Pac-Man Defenses
A target company thwarts a takeover by buying stocks in the acquiring company, then taking them
over.

BUSINESS FAILURE
- refers to a company ceasing operations following its inability to make a profit or to bring in enough
revenue to cover its expenses.

Business Failure is an unfortunate circumstance. The majority of firms that fail do so within the first
year or two of life, other firms grow, mature, and fail much later. The failure of a business can be
viewed a number of ways and can result from one or more causes.

According to the study “Redefining Small Business Success” by the U.S. Small Business
Administration:
 66 % of new businesses survive two years or more
 50 % survive at least four years
 40% percent survive six years or more.

MAIN CAUSES OF BUSINESS FAILURE

1. Poor Business Planning

Business Planning is an on-going process that includes research, locating resources,
understanding the financial statements of the business and continuing to revise the business
plan as things change. The most important document that any business has is its business
plan, which documents what it intends to achieve during the next 12 months and the plan on
how it is to be done.

As the saying goes, failing to plan is planning to fail. If you don’t know where you are
going, you will never get there. A fact rarely considered is that the majority of businesses fail
within a few years mostly due to poor planning or no planning at all. According to a study, 78%
of businesses fail due to the lack of a well-developed plan.

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 Having a comprehensive and actionable strategy allows you to create engagement,
alignment, and ownership within your organization. It’s a clear roadmap that shows where
you’ve been, where you are, and where you’re going next.

2. Poor Financial Planning and Management of Cash Flow

Cash flow is the lifeblood of business, without it a business cannot survive. A common
fatal mistake for many failed businesses is having insufficient operating funds. Business owners
underestimate how much money is needed and they are forced to close before they even have
had a fair chance to succeed. They often lack the necessary start-up funds and can’t come up
with adequate financing.

The poor management of cash flow is the main reason that small businesses fail. In the
financial planning category, 82% of businesses failed due to poor cash flow management skills,
followed closely by starting out with too little money. Business leadership is about taking
financial planning and research, and understanding the unique financial dynamics of one’s
business. Half of UK’s small businesses fail within the first three years because of cash flow
problems. They either run out of money or run out of time. Consumer debt, personal
bankruptcies, and company insolvencies are all now on the increase.

3. Lack of Management Control or Poor Management

One of the major reasons that a business might fail is its management. In the
management category, 70% of businesses fail due to owners not recognizing their failings and
not seeking help, followed by insufficient business experience.

Top management is the backbone of a strong business. Decisions and strategies made
by the management can decide the fate of a business well before it gets off the ground. Many
decision makers are often not aware of the business capabilities and importance of creating
long term strategies and clear achievable goals, there is no point in having strategies or goals if
the management teams you have are not experienced at managing.

Lack of management control is another major reason why businesses find themselves in
difficulties. All businesses need to have a strategic plan to ensure that they are operating in the
best markets with correct margins and adequate level of financial resources. All too often
management spends too much time dealing with day-to-day problems and so fails to address
these fundamental issues.

4. Poor Marketing
Over 64% of business surveyed in marketing category failed because their owners
ignored the importance of properly promoting their business and ignored their competition. A
business leader must be able to effectively communicate the idea to the right people and
understand their unique needs and wants. Leadership is all about taking initiatives, taking
action, getting things done, and making decisions. If you are not doing anything of significance
to the market and promote your business, you are most likely headed to business failure.

 Failure to understand your market and customers

It is vital to understand your competitive market space and your customers’ buying
habits. Answering questions about who your customers are and how much they’re willing to
spend is a huge step in putting your best foot forward. Understanding your customers and what
you can do for them and not what you can do to them.

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  No customer strategy
Be aware of how customers influence your business. Are you in touch with them? Do
you know what they like or dislike about you? Understanding your customer forwards and
backwards can play a big role in the development of your strategy. Learn how to stand out from
your competitors and why people are willing to pay you more for your product or service.

 Opening a business in an industry that isn’t profitable

It is important to choose an industry where you can achieve sustained growth.

 Poor location
If your business depends on passing trade or ease of access, location is key. Before
settling on business premises, make sure you do your research on the area and try to estimate
foot fall.

 Failure to understand and communicate what you are selling

You must clearly define your value proposition. What is the value I am providing to my
customer? Once you understand it, ask yourself if you are communicating it effectively. Does
your market connect with what you are saying?

 Not knowing about your competitors

The more you know, the greater the chances that you will succeed in turning your
business around. Remember, the more you know about them than what they understand about
you, then and only then are you ready to compete by taking away customers from your
competitors. Lack of understanding about the competition and your customers is a killer on its
own.

TYPES OF BUSINESS FAILURE

1. Economic Failure
- The firm is generating losses; that is, revenues are less than costs.
- Depending on the users and context, it could also mean that the rate of return on investment
is less than the cost of capital.
- It could also mean that the actual returns earned by a firm are less than those that were
forecasted.

These uses of the term are very different and cover situations in which a company could
be unprofitable as well as cases in which the company is profitable but not as profitable as
expected.

2. Financial Failure
- Financial Failure means that a company cannot meet its current obligations as they come
due. The company does not have sufficient liquidity to satisfy its current liabilities. This may
occur even when the company has a positive net worth, with the value of its assets
exceeding its liabilities.

REMEDIAL ACTIONS FOR BUSINESS FAILURES

I. REHABILITATION
Rehabilitation attempts the firm going. It may be achieved through the following:

A. Reorganization

Reorganization refers to a formal proceeding under the supervision of a court. It is usually a

revision of the firm’s financial structure including short-term and long-term liabilities as well as

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stockholders’ equity in order to correct gradually the firm’s immediate inability to meet its current
payments.

Reorganization is an attempt to extend the life of a company facing bankruptcy through special
arrangements and restructuring in order to minimize the possibility of past situations reoccurring.

More precisely, business reorganization is the restructuring of a company’s operations in order

to concentrate on core activities, combining two or more organizational units, or readjustment of a
company’s debt and capital structure after a bankruptcy.

Reorganization plans may call for:

1. Refinancing
It refers to the replacement of outstanding securities by the sale of new securities. It may be
classified as:
a. Refunding -It refers to the sale of a new bond issue to replace an existing bond issue.
b. Funding -It refers to the retirement of a preferred stock with the proceeds of a borrowing.
c. Reverse funding -It refers to the issuance of common stocks as a means of paying off
outstanding bond issue.
d. Recapitalization - Recapitalization is undertaken when a group of existing security holders
accepts a new issue in voluntary exchange for the issue it now holds.

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