Declining economic conditions: Impact on business valuation (Final)
The Securities and Exchange Commission (SEC) is the statutory body mandated by the Securities Industry Act 2016 (Act 929) to promote the orderly growth and development of an efficient, fair and transparent securities market in which investors and the integrity of the market are protected.
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In the SEC’s directive number SEC/DIR/002/10/2022, published in October 2022, all fund managers, custodians, and trustees have been directed to use Fair Value through Other Comprehensive Income (Mark-to-Market) valuation method in valuing portfolios of Collective Investment Schemes (Unit Trust and Mutual Funds).
On the other hand, fund managers who may be constrained by their business models from using the Fair Value through Other Comprehensive Income (FVOCI) in valuing their portfolios will need to provide reasons why they cannot comply with this directive.
Such fund managers are at liberty to use any appropriate valuation method as well as compute the FVOCI of their investment portfolios, track the deviations and report to the SEC.
The purpose of the above directive is to ensure that all fund managers are reporting the fair value of their portfolios so that at redemption, an investor would not expect to receive an amount higher than or equivalent to the book value of his investment, especially in a situation where the fair value of such investment is less than its book value.
Mark-to-Market valuations involve adjusting the value of assets to reflect their current market value given prevailing market conditions.
This helps investors understand what they would receive for their assets if they were sold at a particular point in time.
A simple approach to mark-to-market valuation
Assuming an investor holds 20 shares of a stock which was purchased for GH¢5 per share, and that stock now trades at GH¢10 per share, the "mark-to-market" value of the shares is equal to 20 shares X GH¢10, or GH¢200, whereas the book value might (depending on the accounting principles used) equal only GH¢100.
Now let’s assume the current stock price rather falls to GH¢4 per share which is below the initial purchase price of GH¢5 per share.
In this case, the mark-to-market value will be 20 shares X GH¢ 4, or GH¢ 80. Should the investor now want to liquidate his 20 shares which currently trade at GH¢4 per share, he will expect to receive a total value of GH¢80 rather than the initial investment value (book value) of GH¢100.
Importance of mark-to-market valuation
• It is used to measure the fair value of assets and liabilities which are subjected to periodic fluctuations
• Mark to market provides a time-to-time appraisal of such assets and liabilities considering the prevailing market conditions
• Mark-to-market can present a more accurate representation of the value of the assets held by a company or institution when compared to historical cost accounting
Final notes
It should be noted that a rising inflationary environment may lead to cashflow adjustments to ensure that discount rates and the cash flows are consistent and comparable.
Where cash flows reflect current inflationary environment (cash flow in nominal terms), the discount rate adopted should include effects of inflation (nominal rate) and vice versa.
The writers are: Partner and Financial Advisory Leader, and Manager and Team Lead, Valuation & Modelling, Deloitte Ghana
