Justification of Valuation Assumptions by the Expert

A recent article by Andreas Creutzmann in “BewertungsPraktiker” addresses the issue of justifiability of assumptions in business valuations.  Valuations generally contain assumptions on central parameters that have a substantial effect on the outcome.  A common criticism is that in business valuation everything is possible that is in line with common practices and not obviously self-contradictory.  For CPAs, the Germany’s Institute of Public Auditors published 2017 guidelines that address this question in connection with specified purposes (“IDW Praxishinweis 2/2017: Beurteilung einer Unternehmensplanung bei Bewertung, Restrukturierung, Due Diligence und Fairness Opinion”).  This does contain several suggestions on how to rationalize the cash flow forecasts, such as contrasting the projections with past performance, comparing the market analysis with economic analyses, and using analyst reports to examine the competitive analysis.  However, these recommendations cover only the cash flow projections and therefore only the numerator of the valuation calculation.  The author presents an approach that is more generalized and applicable to the denominator as well as to the numerator.  It contains four aspects to be checked: appropriateness of the selected methodology, completeness of the used data, tenability of the numerical amount, and computational accurateness.    The appropriateness of the selected method is to be judged based on its acceptance under current scientific standards as well as under its adoption in practice.  Complete data is given when there is a sufficient informational basis to evaluate the assumptions.  The numerical dimension of the assumption is tenable, if it falls within a range of common and intersubjectively acceptable values.  If these conditions as well as computational accurateness are given, the assumption can be accepted, otherwise it has to be at least further scrutinized.

In our view, this article is a helpful step in developing a framework for the evaluation of assumptions also for valuations in a transfer pricing context.  While typically not emphasized in written studies, transfer pricing valuations – from “simple” benchmarking studies to more complex restructuring-related valuations – regularly involve assumptions that have an influence of the result, specifically the width of the “arm’s-length range”.  While challenges of the applied transfer pricing method are generally more frequent, tax administration also tend to scrutinize and challenge these ranges by attacking their underlying assumptions.  The practitioner is therefore regularly occupied with the question how to justify the selected parameters.  Articles like this contribution by Creutzmann are valuable in equip them with the necessary conceptual framework as well as with reference that can be utilized in discussions with tax examiners. The article by Creutzmann was published in the March 2021 issue of “BewertungsPraktiker” on pages 12 through 14.