Auditing or as we say independent inspection is a process where conclusions/assertion derived by a company are verified by a third party. Is it an art or a science? Some say it is purely science while some say purely an art. If it is a science then audit is done using some set standards but how well do people understand it who use it. If it is an art can it be fully reliable?
From the science perspective, auditing of valuations requires some standards and steps as to how to approach an audit. These are analysis of company’s documents, an analysis of valuation done by client and conducting your own valuation. For an audit to be reliable an auditor needs to follow these steps.
The science of valuations generally says that most common methods of valuation used are income based, asset based, cost based and market based approaches.
From the art perspective a lot of personal skills and judgment is required from auditor’s side in order to derive business valuation. These skills are required especially when one selects multiples, weightings among LTM and NTM figures and drawing conclusions. This is one of the biggest challenge that an auditor as well as a valuation analyst faces.
Also, if you have better insight about the industry for which you are conducting audit and in specific an insight about the business it helps you to ask better questions as an auditor.
The methods so mentioned above, the choice among them depends on the judgment and understanding of the auditor. For example, one auditor may apply a market multiple to company having revenues of only $2Million while the other may use market approach only if its revenues are greater than $10Million.
Also, at times an auditor may find hybrid of approaches appropriate to determine value. Now, weightage among such hybrid of approaches is an art which the auditor possesses.
In order to provide accurate audit, an auditor needs to be updated about the changes taking place in the competitive environment and also about the technological developments taking place in the rapid developing world.
Audit reports are not only used by investors but they cater to the needs to a large number of users such as investment bankers, hence, auditor must have the art to audit taking in view the need of all users.
Henceforth, Auditing of valuations is a challenge which involves application of both science and art of auditing. It is one of the greatest responsibility of the auditor to build confidence in the investors, the PEs and VCs on the audit they provide.