Tabriz MirzayevAudit and Valuation PartnerLet\'s start by mentioning the number of listed companies in Azerbaijan. Besides commercial banks and a few financial institutions, how many listed companies can you count? Just a few! When a company\'s shares are not publicly traded, the accuracy of its financial statements is of interest to only a limited group of readers and users, typically including the following:Tax Authorities;Existing Shareholders.Before starting to discuss the reliability coefficient of financials received from aforementioned groups and to what extent you could rely on them let\'s explain why we need accurate financials.The market capitalization of the target company is essential for the acquirer or for synergy purposes in terms of:Ensuring Fair Value: As an acquirer, you are interested in not paying more than the target company\'s real market value. This helps in making sure that the investment is justified and that you are not overpaying for the acquisition.Assessing Financial Health: For synergy purposes, the parties should be comfortable that your company is financially healthy and that the synergy will bring its benefits. This confidence is crucial for achieving the anticipated cost savings, revenue enhancements, and overall efficiency improvements.To be comfortable with the above points, you should have accurate financial information, which is summarized and reflected in the financial statements prepared for the corresponding period. More precisely, I would replace the word \"accurate\" above with the word \"audited\" as, at least in this context, I believe they are synonyms.Most likely, your consultants will choose one of the two valuation methods: either income-based or asset-based. Regardless of which method they choose, they will need precise elements from the financial statements (net profit, costs, fixed assets, inventories, cash flow, etc.) to employ a comprehensive valuation approach.Reliability of Financial information received from:Tax Authorities - The primary users of financial statements for all registered companies in Azerbaijan are the tax authorities. The reason for this is straightforward: they are responsible for implementing the Tax Code and collecting taxes from entities operating in Azerbaijan. Therefore, all entities must complete their tax returns, showing elements such as net profit, turnover, assets, etc., which are subject to relevant taxes. Financial statements are prepared in accordance with the Tax Code of Azerbaijan, following rule-based accounting treatments. So, can we rely on the financials of a target company when we intend to acquire it? The answer to this question may seem subjective and depends on your risk tolerance.Here are some points to consider in forming your own answer:Not all tax returns submitted are inspected in detail by the relevant tax authorities.Based on my experience, the balance sheet attached to the tax return often includes some questionable balancing figures like \"Other Assets,\" \"Other Liabilities,\" and \"Other Equity elements.\" In most cases, these figures are material.Financial statements submitted to the tax authorities do not include a cash flow statement, which is essential for analyzing cash generated from operating activities.The financial statements presented to you may not be final and could be misleading.Existing Shareholders - In the Azerbaijani business environment, shareholders are often the founders of the business. Therefore, they believe they know every small detail about their business, including its financial structure and operational health. They often have special-purpose financial reports that are usually inappropriate for M&A purposes.As an investor with sufficient funds, I would avoid relying solely on tax returns and special-purpose financial statements prepared for shareholders to analyze the financial health of a target company.What will the external audit give you?Since the asset-based valuation approach is not widely used and selecting appropriate multiples for publicly listed companies has proven ineffective for us, we will focus on the key elements of the flow-based valuation approach (DDM, RIVM, DCF), which is the most reliable method in our context.(We are not going to analyze and discuss the estimation of discount rates such as CoE and WACC, as the articulation between discount rates and accurate accounting figures is a topic with a broad scope and warrants a separate article)Which reliable derivatives should be produced from audited financial statements to obtain a precise market value for your target company operating in Azerbaijan?Dividends: Although accurate dividend payments can be used to obtain a reliable intrinsic value for a target company, if we employ the same ratio that we have for our audit and valuation portfolio (excluding companies partially owned by the government), we find that approximately 70% of Azerbaijani companies either do not pay dividends or have an unstable dividend payment trend, making future dividend projections unreliable. Therefore, I believe we could exclude the Discounted Dividend Model from the flow-based valuation approach as well.Net income: After a comprehensive external audit, you can be confident about the net profits of your target company, and your consultants can implement the Residual Income Valuation model to determine its intrinsic value. However, considering the shareholders\' awareness of the determined return rate on capital employed, your consultants will barely be able to obtain the required rate of return for the capital employed during the corresponding period to generate residual incomes. In simple terms, to determine the residual incomes, the cost of capital (capital invested multiplied by the required rate of return) is deducted from the net profits. This flow-based valuation model is considered one of the more reliable ones, but obtaining a precise required rate of return can be challenging. Moreover, using the book value of equity to generate residual income could also have some negative points. But anyway, net profit is what we need ultimately, and it will be used for the next flow-based valuation model as well.The elements from audited financial statements used to yield the free cash flows for the Discounted Free Cash Flow (DCF) valuation model include:Net Income;Depreciation and Amortisation (D&A);Changes in Working Capital;Capital expenditures (CapEx).FCF = Net Income + Depreciation and Amortization − Changes in Working Capital − Capital Expenditures.Since Free Cash Flow (FCF) represents the actual amount that can be paid to shareholders, it is considered a very reliable input for determining the market value of the target company. It is also an alternative to dividends for assessing the company’s value.So, it is crucial to have all the above elements accurate to ensure they do not affect the market value of the target company and deviate from its real value.Other key factors can be derived from external audit of financial statementsRevenue analysis: You will ensure that the revenues are real, not solely generated from one or two customers, and are not related-party transactions.Historical performance: Even if it is the first time that there is an external audit for the target company (if it has been registered for at least three years and was not dormant), you will see at least three years\' balances in the financial statements. This historical data will be helpful in setting future projections for the corresponding forecasting period and the period beyond the horizon (for terminal value).R&D expenses: One of the best indicators of a company\'s future is its R&D expenses, which show that the company is not staying in one place and has an intention to expand.Cross check anaylsis: Digits versus the words of management or shareholders of the target company. You will obtain accurate figures to compare with the strategy and plans of the management of the target company and see if they follow the same direction.Closing wordsAlthough this article does not include sample sizes, there are numerous articles in this field that affirm the crucial role of accounting figures in determining the market value of a company.In summary, obtaining accurate and audited financial statements is crucial for a reliable valuation of a target company, especially in a market like Azerbaijan where financial transparency can be limited. The choice of valuation methods, whether flow-based models like the Residual Income Valuation Model (RIVM) or the Discounted Cash Flow (DCF) model, relies heavily on the precision of these financial elements. By ensuring the integrity and accuracy of net income, depreciation and amortization, changes in working capital, and capital expenditures, investors can make well-informed decisions and accurately determine the market value of their target companies. Reliable financial data not only ensures fair value assessments and sound investment decisions but also supports the confidence needed for successful mergers, acquisitions, and strategic partnerships.

BLOG by Rhys Madoc, CEO, UHY InternationalJune 2022Source: www.uhy.comIn the post pandemic world of work, robust cybersecurity defences are more crucial than ever.That is not saying anything that most of us don’t know, but it is worth repeating. The pandemic has accelerated digital transformation, making us all much more reliant on online tools and services than we were just two years ago.In our profession, we have seen a significant shift to using cloud-based bookkeeping software; and our clients expect to be able to contact us over Zoom, Teams or chat, as well as in person. We store more critical data in digital strongrooms, either in the cloud or on in-house servers.Across the corporate world, reputations, revenue and even the futures of businesses rely on being able to keep that information safe. That is not an easy task. Cybercriminals are a determined foe.DOING THE SIMPLE THINGS - EVERY TIMEHowever, as determined as the criminals are, the reputation of cybercrime can sometimes exceed its reality. Cybercrime is rarely rocket science. The things you need to do to foil most attackers are actually quite simple - you just need to do them again, and again, and again.That means not just investing in an enterprise grade firewall, but making sure it is always updated to the latest version. It means backing up data on a daily basis. It means buying and applying Virtual Private Network (VPN) licences for employees connecting to your network remotely and making sure they use them.And perhaps most of all, it means making caution routine. Deleting an email that contains a link you don’t recognise once is not enough. You have to avoid clicking suspicious links every time you encounter them, from now until forever.That is a tough ask, because it requires constant vigilance. Drop your guard on just one occasion and the hackers might be in.THE HOLISTIC APPROACH TO CYBERSECURITYThat stark truth is confirmed by statistics. A recent report found that 85% of data breaches have a human aspect (source: Verizon, Data Breach Investigations Report 2022). The average cost of a data breach, meanwhile, is an eye watering USD 4.24 million according to IBM (source: IBM.com/security).How do you avoid the calamity of a major cybersecurity incident? It takes a holistic approach, which certainly includes technology, and might require third party support.Many UHY member firms around the world now offer cybersecurity as a professional service. Our US firm, for example, operates a rapid response unit, which has a formidable reputation for forensically investigating security breaches and containing threats before significant damage can be done.EDUCATION IS YOUR FIRST LINE OF DEFENCEBut whatever else you do, your cybersecurity strategy absolutely must include employee education. In one telling study, 61% of employees failed a cybersecurity quiz, and 60% of those that failed said they felt safe from online threats (source: talentlms.com cybersecurity survey).In my opinion, that sort of misplaced confidence is as big a threat to your organisation as an unpatched server. Cybersecurity training should now be compulsory for all employees, as part of a process of continuing learning. Annual refresher courses should cover at least the basics, from recognising phishing attacks and securing mobile devices to connecting securely to your network from outside the office.Or to put it another way, cybersecurity needs to become a habit. Your resilience to cyber attacks depends on the continuous vigilance of every member of your organisation.So put the tools in place, from firewalls and antivirus software to intrusion detection and prevention systems. But remember that cyber resilience is as much about instilling a culture of caution as it is investing in the latest technology. As an organisation, you are only as strong as your weakest link.Image acknowledgements: Microsoft 365 subscriber content