Valuing businesses and their underlying assets is more challenging today than at any other time in recent history.
Despite growing signs that the global economy is regaining its health, it is likely that recovery will be gradual for most and fragile for many.
What is not in doubt is that market confidence was severely impacted in virtually every area of the global economy. Whatever the timeline for recovery, boards will continue to find it challenging to deliver the future performance and returns needed to satisfy investors.
In the meantime, scarcity of capital and increased risk aversion are driving investors and lenders to focus on the reliability of information used to make investment decisions. In our experience, valuing businesses and their underlying assets is more challenging today than at any other time in recent history and prolonged uncertainty will only continue to add complexity to valuation assumptions.
Our discussions with companies, financial institutions, governments and regulators around the world indicate that, for many, this level of uncertainty will be part of the landscape for some years to come.
Survey findings
Against this background we have asked those who use financial statements to tell us how they interpret impairment reporting, the information they find most valuable and their expectations for the next 18–24 months.
We surveyed 170 users of financial statements during September and October 2009, including investors, analysts and lenders in 32 countries. In addition, we sought regulators’ views on certain aspects of impairment. These are the major findings from our survey:
- More than half of the respondents were unconvinced that the global recovery is under way. Interestingly, lenders were notably more pessimistic about the state of recovery than other stakeholders.
- Most believe that the level of impairments to date are below expectations, and that the real estate, banking and capital markets, and automotive sectors are the most likely to experience further impairments.
- More than 90% indicated that forecasting cash-flows in the next 12–18 months will be either challenging or very challenging.
- More than 90% use impairment information disclosed in financial statements in their investment or lending decision-making process.
- Management, when communicating impairment, needs to place at least as much importance on the impact of the impairment on the future prospects of the business as it does on the size, magnitude and reason for the impairment.
In another recent survey of European CFOs by Ernst & Young, many indicated greater interest in understanding impairments in the current economic environment. Many also indicated a need to better understand other issues that have valuation implications (e.g., business prospects, debt covenants, restructuring plans). The views expressed by these CFOs align with the findings of our survey regarding the need for greater transparency.
Where do investors show more interest,
as a result of market conditions?
Variations in accounting standards and interpretation of IFRS, particularly around financial instruments, add further complexity.
Furthermore, although valuation standards exist in several countries, a globally-consistent set of valuation standards does not exist. We believe that greater transparency could be achieved through a single set of high-quality international accounting and valuation standards, which would also make for easier comparison with similar companies for stakeholders.
To build confidence with investors, analysts, lenders and regulators, leading companies will need to adopt a robust and integrated impairment testing process addressing four key steps:
- Escalate to the highest levels of the organization. While the finance team is the likely owner of the impairment process, input from and collaboration with others in the company and valuation specialists are required. Senior management input on the key assumptions about the business and the environment is critical.
- Integrate with capital management and strategic planning. Management should embed the overall assessment of impairment in its strategic planning and capital management processes.
- Improve reliability of valuation with better forecasting information. Companies should reflect the latest analyses of economic and industry trends in their cash-flow projections of and determination of appropriate discount rates.
- Communicate the information that stakeholders need. Stakeholders will require improved transparency through more effective communication and disclosures of the assumptions management has used and the sensitivity analysis it has conducted.
We believe those companies that successfully focus on these areas and provide well-prepared financial statements, alongside clear and consistent explanations about business prospects and management’s approach to determining asset values, will build the greater confidence and trust with their stakeholders, and ultimately have the better access to capital.
