Today, I would be writing on how regression analysis could be use in determining the effect of other variables on not just the firm’s but also how interrelated each variable on the financial statement is.
For ease of understanding, I would be writing on the impact of financial distress on firm’s value. In this case, we would look at the firm’s value and financial distress. The variables would be divided into depended and independent variables. Any change in depended variable is caused by change in independent variables. The depended variables in this case is the firm’s value while the independent variables are the measure of financial distress in a company: liquidity, net profit margin, return on asset ratio, interest coverage ratio, cash operating cycle.
We have different method for calculating firm value:
One method is Enterprise Value method. This method estimates firm value by adding the market value of equity + market value of preferred share + market value of debt + market value of minority interest – cash and cash equivalent. This method includes not just the value of equity but also value of debt and cash reserve of the company since all these variables has important role to play in corporation valuation.
The second method is call operating free cash flow method. This method estimates the value of a firm by determining the present value of its future operating free cash flows. If two firms of relatively the same size and operating in the same industry, the company with higher operating cash flows would be valued more than company with lower operating free cash flow. Operating free cash flow is calculated by adjusting the tax rate, adding all non-cash transaction (depreciation, amortization) and deducting the amount spent on capital expenditure, working capital and changes in other assets from earnings before interest and taxes.
The Third method is the book value method. Book value method of estimating firm’s value is one of the easiest and most straight forwards. The book value method values the firm as reflected in its financial statement. It is the differences between the assets and liabilities of the company as reported on their financial statement. It is the true value of the business when all the liabilities are taking out of the firm’s assets. For example, a company with a total assets value of N1b and its liabilities of N300m would have a book value of N700m as its value.
The final method of estimating firm’s value that I would consider today is the market value method. Under this method, the market value also known as market capitalization of the company is taking as reflected on the stock exchange. This method is ideal for company that is listed on the stock exchange. It is calculated by multiplying the company’s outstanding share by its current market price as quoted on the stock exchange. For example, if company A has an outstanding share of 20 million and the market price of each share is N30, the market value of company A would be N600 million assuming that the company issue only common stock.
To be continued
The books of Prime Entry in Accounting