"There are a number of factors both macro-economic and micro-economic which have an impact on business. Valuation of a business involves making forecasts for the future". Comment on the sources of uncertainties in busine

Sources of Uncertainties: Uncertainty is part and parcel of the valuation process both at the point of time when the valuation is made and also on basis of how the business evolves over time. The valuation involves a process where the valuer has to make various forecasts about the future both in terms of general economic conditions as well as how the firm will perform individually. Valuation uncertainty is defined as 'The possibility that the estimate value may differ from the price that could be obtained in a transfer of the same asset or liability taking place at the same time under the same terms and within the same market environment'. It is important to note that a valuation is not a fact; it is an estimate of the most probable of a range of possible outcomes based on the assumptions made in the valuation process. Market valuations are estimates of the most probable price that would be paid in a transaction on the valuation date. However, even where assets are identical and exchanged in contemporaneous transactions, fluctuations in the prices agreed between different transactions can often be observed. These fluctuations can be caused by factors such as differences in the objectives, knowledge or motivation of the parties. Consequently, an element of uncertainty is inherent in most market valuations as there is rarely a single price with which the valuation can be compared. The valuation involves a process where the valuer has to make forecasts about the future both in terms of general economic conditions as well as how the firm will perform individually. Uncertainties caused by these various conditions and factors can be broadly categorized into the following three groups based on the reasons / sources of these uncertainties. Estimated/Model/Input Uncertainty: Even if our information sources are impeccable, we have to convert raw information into inputs and use these inputs in models. Any mistakes or mis-assessment that we make at either stage of this process will cause estimation error. Further, uncertainty arises from characteristics of either the valuation model, or method, used. For certain asset types, more than one method may be customarily used to estimate value. However, those models may not always produce the same outcome and therefore the selection of the most appropriate method may of itself be a source of uncertainty. Also uncertainty arises where there are a number of equally reasonable or feasible inputs or assumptions that can be used from the degrees of veracity that can be attached to the data inputs used in the valuation and their impact on the outcome. Firm-specific Uncertainty: The specific risks associated with the firms Business, Modus Operandi may also add to uncertainty in the business valuation. The firm may do much better or much worse than we expected it to perform, and the resulting earnings and cash flows will be very different from our estimates. Macroeconomic Uncertainty/Market Uncertainty: Even if a firm evolves exactly the way we expected it to, the macroeconomic environment can change in unpredictable ways. Interest rates can go up or down and the economy can do much better or worse than expected. These macroeconomic changes will affect value. Further, uncertainty arises when a market is disrupted at the valuation date by current or very recent events such as sudden economic or political crises. The disruption can manifest itself in a number of ways, for example, either through panic buying or selling or by a loss of liquidity due to disinclination by market participants to trade. An outbreak of sudden trading activity in response to a crisis may cause rapid price changes that are not necessarily representative of those that would be agreed between parties acting "knowledgeably and prudently". Conversely, a loss of liquidity will mean fewer contemporaneous or relevant recent transactions which may impact on the reliability of the valuation.