Uncategorized

One way to calculate a business’s valuation is to subtract liabilities from assets. However, this simple method doesn’t always provide the full picture of a company’s value. This is why several other methods exist.

Here’s a glimpse at six business valuation methods that provide insight into a company’s financial standing, including book value, discounted cash flow analysis, market capitalization, enterprise value, earnings, and the present value of a growing perpetuity formula.

1. Book Value

One of the most straightforward methods of valuing a company is to calculate its book value using information from its balance sheet. Yet, due to the simplicity of this method, it’s notably unreliable.

To calculate book value, start by subtracting the company’s liabilities from its assets to determine owners’ equity. Then, exclude any intangible assets. The figure you’re left with represents the value of any tangible assets the company owns.

2. Discounted Cash Flows

Another method of valuing a company is with discounted cash flows. This technique is highlighted in Leading with Finance as the gold standard of valuation.

Discounted cash flow analysis is the process of estimating the value of a company or investment based on the money, or cash flows, it’s expected to generate in the future. Discounted cash flow analysis calculates the present value of future cash flows based on the discount rate and time period of analysis.

Discounted Cash Flow =

Terminal Cash Flow / (1 + Cost of Capital) # of Years in the Future

The benefit of discounted cash flow analysis is that it reflects a company’s ability to generate liquid assets. The challenge of this type of valuation, however, is that its accuracy relies on the terminal value, which can vary depending on the assumptions you make about future growth and discount rates.

3. Market Capitalization

Market capitalization is one of the simplest measures of a publicly traded company’s value. It’s calculated by multiplying the total number of shares by the current share price.

Market Capitalization = Share Price x Total Number of Shares

One of the shortcomings of market capitalization is that it only accounts for the value of equity, while most companies are financed by a combination of debt and equity.

In this case, debt represents investments by banks or bond investors in the company’s future; these liabilities are paid back with interest over time. Equity represents shareholders who own stock in the company and hold a claim to future profits.

Let’s review enterprise values—a more accurate measure of company value that considers these differing capital structures.

4. Enterprise Value

The enterprise value is calculated by combining a company’s debt and equity and then subtracting the cash amount not used to fund business operations.

Enterprise Value = Debt + Equity – Cash

To illustrate this, let’s explore three well-known car manufacturers: Tesla, Ford, and General Motors (GM).

In 2016, Tesla had a market capitalization of $50.5 billion. On top of that, its balance sheet showed liabilities of $17.5 billion. The company also had around $3.5 billion in cash in its accounts, giving Tesla an enterprise value of approximately $64.5 billion.

Ford had a market capitalization of $44.8 billion, outstanding liabilities of $208.7 billion, and a cash balance of $15.9 billion, leaving an enterprise value of approximately $237.6 billion.

Lastly, GM had a market capitalization of $51 billion, balance sheet liabilities of $177.8 billion, and a cash balance of $13 billion, leaving an enterprise value of approximately $215.8 billion.

While Tesla’s market capitalization is higher than Ford and GM, Tesla is also financed more from equity. In fact, 74 percent of Tesla’s assets have been financed with equity, while Ford and GM have capital structures that rely much more on debt. Nearly 18 percent of Ford’s assets are financed with equity and 22.3 percent of GM’s.

5. EBITDA

When examining earnings, financial analysts don’t like to look at a company’s raw net income profitability. It’s often manipulated in a lot of ways by the conventions of accounting, and some can even distort the true picture.

To start with, the tax policies of a country seem like a distraction from the actual success of a company. They can vary across countries or time, even if nothing changes in the company’s operational capabilities. Second, net income subtracts interest payments to debt holders, which can make organizations look more or less successful based solely on their capital structures. Given these considerations, both are added back to arrive at EBIT (Earnings Before Interest and Taxes) or “operating earnings.”

In normal accounting, if a company purchases equipment or a building, it doesn’t record that transaction all at once. The business instead charges itself an expense called depreciation over time. Amortization is the same as depreciation but for things like patents and intellectual property. In both instances, no actual money is spent on the expense.

In some ways, depreciation and amortization can make the earnings of a rapidly growing company look worse than a declining one. Behemoth brands, like Amazon and Tesla, are more susceptible to this distortion since they own several warehouses and factories that depreciate in value over time.

Understanding how to arrive at EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for each company makes it easier to explore ratios.

According to the Capital IQ database, Tesla had an Enterprise Value to EBITDA ratio of 36x. Ford’s is 15x, and GM’s is 6x. But what do these ratios mean?

6. Present Value of a Growing Perpetuity Formula

One way to think about these ratios is as part of the growing perpetuity equation. A growing perpetuity is a financial instrument that pays out a certain amount of money each year—which also grows annually. Imagine a stipend for retirement that needs to grow every year to match inflation. The growing perpetuity equation enables you to find today’s value for that financial instrument.

The value of a growing perpetuity is calculated by dividing cash flow by the cost of capital minus the growth rate.

Value of a Growing Perpetuity = Cash Flow / (Cost of Capital – Growth Rate)

So, if someone planning to retire wanted to receive $30,000 annually, forever, with a discount rate of 10 percent and an annual growth rate of two percent to cover expected inflation, they would need $375,000—the present value of that arrangement.

What does this have to do with companies? Imagine the EBITDA of a company as a growing perpetuity paid out every year to the organization’s capital holders. If a company can be thought of as a stream of cash flows that grow annually, and you know the discount rate (the company’s cost of capital), you can use this equation to quickly determine the company’s enterprise value.

To do this, you’ll need some algebra to convert your ratios. For example, if you take Tesla with an enterprise-to-EBITDA ratio of 36x, that means the enterprise value of Tesla is 36 times higher than its EBITDA.

If you look at the growing perpetuity formula and use EBITDA as the cash flow and enterprise value as what you’re trying to solve for in this equation, then you know that whatever you’re dividing EBITDA by is going to give you an answer that is 36 times the numerator.

To find the enterprise value to EBITDA ratio, use this formula: enterprise value equals EBITDA divided by one over ratio. Plug in the enterprise value and EBITDA values to solve for the ratio.

Enterprise Value to EBITDA Ratio = EBITDA / (1 / Ratio)

In other words, the denominator needs to be one thirty-sixth or 2.8 percent. If you repeat this example with Ford, you’d find a denominator of one-fifteenth or 6.7 percent. For GM, it would be one-sixth or 16.7 percent.

Plugging it back into the original equation, the percentage equals the cost of capital. You could then imagine that Tesla might have a cost of capital of 20 percent and a growth rate of 17.2 percent.

The ratio doesn’t tell you exactly, but one thing it highlights is that the market believes Tesla’s future growth rate will be close to its cost of capital. Tesla’s first-quarter sales were 69 percent higher than this time last year.

Leveraging Growth for Higher Company Valuation

In finance, growth is powerful. It explains why a smaller company like Tesla carries a high enterprise value. The market has taken notice that, while Tesla is much smaller today than Ford or GM in total enterprise value and revenues, that may not always be the case.

Growth not only measures a company’s current achievements but predicts its future potential. Companies viewed as growth leaders attract investors willing to pay a premium for the promise of future returns. This is especially true in industries where innovation leads to market disruption.

Moreover, prioritizing growth drives companies to innovate and expand, setting the stage for long-term success. Understanding this trajectory is vital for leaders and investors, as it goes beyond current financials to envision future potential.

This forward-looking approach sets market leaders apart, allowing them to strengthen their position and reshape their industries through growth.

Gift tax in India is applied when the value of the received gift exceeds ₹50,000 in the financial year. Gifts from non-relatives valued over ₹50,000 are taxable in India. The tax rate depends on your income tax slab (5%-30%). However, gifts from close relatives like parents, spouses, or siblings are tax-exempt. When calculating income tax on gifts received, the taxable value must be reported under “Income from Other Sources” while filing the ITR. As the Gift Tax Act 1958 was removed in 1998, the Gift Tax in India is included and regulated under the Income Tax Act.  This article will delve deeper into the taxes on gift under the Income Tax Act, its applicability, exemptions and how the taxable value is determined.

What is a ‘Gift’ under Income Tax Act?

A “Gift” under Income Tax Act refers to any money, immovable property, or movable property received by an individual from another person or organisation without any payment in return. This means the recipient doesn’t have to give anything in return to acquire the gift. From a taxation perspective, income tax gifts can be categorised into three main types:

• Monetary Gifts: Monetary gifts encompass any money received, including cash, checks, drafts, and bank transfers. Therefore, receiving money in any of these forms could be considered a gift for tax purposes.
• Movable Property Gifts: These include tangible items that can be moved, such as shares, bonds, jewellery, sculptures, paintings, and other valuable possessions. Additionally, the difference is generally considered a gift if a movable property is received at a price lower than its fair market value. For example, if you receive a valuable painting as a gift but the price is significantly less than its market value, the difference between the market value and the price paid would be treated as a gift.
• Immovable Property Gifts: Immovable property, such as land, buildings, and residential or commercial properties, is also considered a gift if received at a price lower than its stamp duty value. This means that the difference between the fair market value and the price paid is treated as a gift.

Gift Tax Exemptions in India

As mentioned, Income tax on gifts received is applicable when the total value of gifts exceeds ₹50,000 in a financial year. But, certain exemptions are available under income tax on gifts received, especially for gifts from close relatives or under special circumstances like weddings or inheritances. Below, we have given a detailed overview of those gift tax exemptions,

Gifts Under ₹50,000: Gifts received up to ₹50,000 during a financial year are exempt from tax. This means that no tax is applicable if the total value of gifts received is below this threshold.

• Property Received for Inadequate Consideration: If property is received for a price higher than its fair market value, the difference between the stamp duty value and the consideration paid is treated as a gift. This excess amount becomes taxable. However, it is exempt if the difference is less than ₹50,000.

• Gifts from Relatives: As per the Income Tax Act, Gifts received from the following relatives are generally exempt from taxes on gifts.
• Spouse of the individual.
• Brother or sister of the individual.
• Brother or sister of the spouse of the individual.
• Brother or sister of either of the parents of the individual.
• Any lineal ascendant or descendant of the individual.
• Any lineal ascendant or descendant of the spouse of the individual.
• Spouse of the persons referred to in (2) to (6).

However, any income generated from these gifts might be taxable under clubbing provisions of Income tax gifts. For example, if a gift is invested and earns interest, the interest income may be taxable.

• Wedding Gifts: Gifts received by a newly married couple from their immediate family members on the occasion of their marriage are comes under the gift tax exemption. This includes cash, jewellery, property, stocks, or gold.
• Gifts by Inheritance or Will: Gifts received through inheritance or a will are exempt from gift tax under the Income Tax Act.
• Gifts from Local Authorities and Charitable Trusts: Money received from local authorities, charitable trusts, funds, foundations, universities, or registered charitable organisations are generally exempt from tax. This also includes money received by meritorious students or patients under medical care.
• Money Received in Contemplation of Death: Similar to inheritance, money received in anticipation of a person’s death is exempt from income tax gift.

How is the Taxable Value of Gifts Determined?

The Income Tax Act provides guidelines on how to calculate the taxable value of gifts, both monetary and non-monetary. Gifts are taxable if they exceed certain limits, and the taxes on gifts depend on the type and value of the gift received. The table below explains how the taxable value is determined for various types of gifts:

Type of Gift	Gift Tax Applicability	Taxable Value of the Gift
Cash, Cheque, or Bank Transfer	If the total value of the gift exceeds ₹50,000	The entire amount received as a gift is taxable
Immovable property (e.g., land or building) received without payment	If the Stamp Duty Value of the property exceeds ₹50,000	The Stamp Duty Value of the property gifted is taxable
Immovable property bought at less than its Stamp Duty Value	If the difference between the Stamp Duty Value and the purchase price is more than ₹50,000	The difference between the Stamp Duty Value and the price paid is taxable. Example: If the Stamp Duty Value is ₹6 lakh and the purchase price is ₹4 lakh, the taxable amount is ₹2 lakh (6 lakh – 4 lakh).
Assets like jewellery, shares, paintings, and sculptures received without payment	If the Fair Market Value exceeds ₹50,000	The Fair Market Value of the asset is considered the taxable amount
Assets like jewellery, shares, paintings, and sculptures purchased and then gifted	If the Fair Market Value exceeds the original purchase price by more than ₹50,000	The taxable amount differs between the Fair Market Value and the original purchase price. Example: If a piece of jewellery has a Fair Market Value of ₹3.5 lakh and was originally bought for ₹2 lakh, the taxable amount is ₹1.5 lakh (3.5 lakh – 2 lakh).

How to Declare Gift Tax in India?

Gift tax is a form of direct tax levied on a gift recipient. In India, the recipient is responsible for declaring the value of the gift in their income tax return (ITR).

• Determine Taxable Value: Calculate the taxable value of the gift. This typically involves subtracting any exemptions or deductions that may apply.
• Include in ITR: Report the taxable value of the income tax gift under the “Income from Other Sources” category in your ITR.
• Compute Tax Liability: The taxable value of the gift is added to your total income for the financial year. Use your income tax slab rate to calculate the tax liability.
• Pay Tax: Pay the calculated gift tax amount along with your other income tax liabilities.

Gift Tax Provisions Relating to Stamp Duty

The stamp duty value is crucial when calculating gift tax on immovable property. Similar to the provisions under Section 50C, the stamp duty value is considered for determining the taxable amount in the case of property gifts. However, this value can sometimes be higher due to various factors, such as delays between the agreement and registration dates. Below, we discuss key provisions related to stamp duty value for gift tax purposes:

• Stamp Duty Value on the Agreement Date: If there is a gap between the date of the agreement and the date of registration, the stamp duty value on the agreement date is used for calculating gift tax, provided the following conditions are met:
• The dates of agreement and registration are different.
• Part or full payment is made through an account payee cheque, bank draft, or electronic transfer on or before the agreement date.
• Disputed Stamp Duty Value: If a taxpayer disputes the stamp duty value used by the stamp duty authority, the tax officer must refer the case to a Valuation Officer (VO). The VO will review the records, offer the taxpayer an opportunity to present their case, and then issue a written order stating the value. The lower value determined by the VO can be considered for gift tax purposes.
• Relaxation under Section 56(2)(x): If the stamp duty value exceeds the consideration received for the gifted property, a relaxation of up to 10% of the consideration is allowed. This excess amount will not be considered income from other sources.

Conclusion

In conclusion, gift tax in India applies to gifts exceeding ₹50,000, with several exemptions available for specific situations, such as gifts from relatives, wedding gifts, and inheritances. While gifts are taxed under the “Income from Other Sources” category in the Income Tax Act, the provisions provide guidelines on how to determine the taxable value for various forms of gifts, including monetary, movable, and immovable property. Exemptions, valuation methods, and considerations related to stamp duty help ensure the fair assessment of taxes on gifts, thereby simplifying the tax process for recipients.

Courtesy: Indiafilings

Tax Deducted at Source (TDS) on Interest Income: Due Dates for Payments and Returns

Understanding TDS on Interest Income

Section 194A of the Income Tax Act, 1961, mandates the deduction of tax at source on specific types of interest income. This mechanism ensures the timely collection of tax liabilities by the government.

Types of Interest Income Subject to TDS:

• Interest on Deposits:
  • Fixed Deposits (FDs)
  • Recurring Deposits (RDs)
  • Company Deposits
• Interest on Loans and Advances: Interest received on loans and advances may be subject to TDS under certain conditions.

TDS Applicability Thresholds:

• TDS is generally applicable when the annual interest income exceeds specific thresholds (e.g., Rs. 40,000 for individuals below 60 years and Rs. 50,000 for senior citizens for FDs).

TDS Rates:

• With PAN: 10%
• Without PAN: 20%

Exemptions and Deductions:

• Interest on Savings Accounts: Generally exempt from TDS.
• Interest Income Below Threshold: Individuals can claim exemption by submitting Form 15G (below 60 years) or Form 15H (senior citizens) if their total interest income remains below the taxable limit.

TDS Payment Due Dates:

• General Rule: The entity paying the interest income is typically responsible for deducting TDS within seven days from the end of the month in which the interest payment is made.

TDS Return Filing Due Dates:

• Quarterly Basis:
  • Q1 (April-June): July 31st
  • Q2 (July-September): October 31st
  • Q3 (October-December): January 31st
  • Q4 (January-March): May 31st of the following year

Key Considerations:

• Responsibility of the Payer: The entity making the interest payment is legally obligated to deduct TDS and fulfill the necessary reporting requirements.
• Penalties for Non-Compliance: Failure to comply with TDS regulations can result in penalties and interest charges for the entity responsible for the deduction.
• Importance of Accurate Record-Keeping: Maintaining meticulous records of interest income received and TDS deducted is crucial for both the payer and the recipient for tax compliance purposes.

Additional Details:

• TDS Certificate: The entity deducting TDS is required to issue a TDS certificate (Form 16A) to the recipient, which details the amount of TDS deducted.
• Tax Credit: The recipient can claim the TDS deducted as a credit against their overall tax liability during income tax return filing.
• Excess TDS Deduction: If TDS is deducted at a higher rate than applicable, the recipient can claim a refund during income tax return filing.