While various methods exist for valuation, it is critical to use multiple approaches, make prudent assumptions, and account for all economic factors impacting the subsidiary’s fair value. This provides a realistic view of minority interest and how it flows through to overall consolidated financial reporting. Discounted cash flow (DCF) analysis is considered the most rigorous approach for valuing a subsidiary as part of a minority interest calculation. The DCF model forecasts the subsidiary’s unlevered free cash flows over a projection period, applying assumptions for revenue growth, margins, capital expenditures, depreciation, taxes, and working capital. Beyond discounted cash flow analysis, valuation multiples can provide another technique for valuing a subsidiary as part of a minority interest calculation.
- Goodwill represents the amount the company pays above the fair value of the equity.
- There are laws that also entitle minority interest holders to certain audit rights.
- As such, their portion of the subsidiary’s equity and net income are reported separately.
- Majority interests typically represent over 50% of the company’s equity, while minority interests typically range between 20% and 30%.
- Unfortunately, it is quite difficult to perform due to lack of disclosures by the parent company.
- A subsidiary is an entity that is controlled by another entity that owns more than 50% of its voting stock.
The most common examples of minority interests occur in subsidiaries where a parent company holds over 50% of voting shares. However, it is also possible for a parent company to exert a controlling interest without a majority stake. This may be the case with variable interest entities that exert control through a contractual obligation rather than ownership. Financial reporting for minority interest only occurs when the parent company prepares separate and consolidated financial statements. For active minority owners, accountants treat the dividend as capital returns, decreasing the investment’s value on the balance sheet. The percentage of income credited to the minority interest adds to the balance sheet’s investment account, increasing the equity share in the company.
It represents the portion of the subsidiary’s net income that is allocable to the minority shareholders. The final accounting treatment of minority interests concerns the term consolidation method. In this method, the acquirer (parent company) owns a substantial stake in the company, exceeding 50% ownership. Unlike passive interest accounting, companies https://turbo-tax.org/ record dividends and a percentage of income on the income statement for active minority interests. In conclusion, minority interest is an important aspect of corporate finance and ownership. It can provide protection and representation for minority shareholders, facilitate the raising of capital, and promote good corporate governance.
Specifically, they can impact financial reporting, valuations, and deal structuring. In the historical growth method, previous financials are analyzed to ascertain existing trends. The model predicts the growth of a subsidiary at a rate based on past trends. However, this method is not applicable to companies experiencing dynamic growth or severe decline. If we do not wish to add the minority interest to Enterprise Value, we would only include 80% of ABC’s Total Sales, EBIT, and EBITDA in the calculation of the various valuation ratios.
Having an NCI gives you a stake in the business, and not needing to put in more money helps diversify one’s portfolio and reduces concentration risk. As a result, the existence of substantial minority interests can reduce EV/EBITDA multiples and thus lower valuations. Acquirers need to assess the impact of minority stakes and make appropriate adjustments to valuation models. This allows investors to clearly see what portion of the subsidiary’s net earnings belongs to the parent versus outside investors. Since Enterprise Value-based metrics like Revenue, EBIT, and EBITDA all include 100% of Sub Co.’s numbers, Enterprise Value must also reflect 100% of Sub Co.’s value.
Applying Valuation Multiples to Minority Interest
Minority interest is an ownership stake in a corporation that is less than 50%. This portion is held by an individual or organization that is not the parent company or the main actors of the business. A minority interest is still considered to be a large stake of ownership, more than just a few shares that a retail investor would hold. Since control is obtained when the ownership percentage goes above 50%, investing 51% will guarantee control and will present less risk to capital compared to an investment of 100%. Second, it may be hard to acquire all shares in a subsidiary, since some of the existing shareholders may not be willing to part with their stock. The concept of minority interest is applied only when the ownership share in a subsidiary exceeds 50% but is less than 100%.
This impacts minority interest, as liabilities can reduce the overall net asset value. Analysts must discern between operating, financial, and off-balance sheet liabilities and understand consolidation procedures. You’ll learn the definition of minority interest, why it’s important, and how accounting for minority interest to calculate it using the balance sheet approach, income statement approach, and consolidation method. Passive minority interests are those where a minority shareholder owns less than 20% of the equity in a subsidiary company, giving them no material influence on the company’s decisions.
The income statement method calculates minority interest expense each period, while the balance sheet approach determines minority interest at a point in time. Failing to properly account for minority interest can greatly misrepresent financial position and performance. On the Radar briefly summarizes emerging issues and trends related to the accounting and financial reporting topics addressed in our Roadmaps. In 2007, the Financial Accounting Standards Board introduced the phrase “non-controlling interest” as a synonym for minority interest.
Referring to the rule, any company owning the majority of shares must reconcile the financials of both the parent and subsidiaries, even if the owner doesn’t equal 100 percent. Most investors in publicly listed companies hold a non-controlling interest and are known as Minority Shareholders. However, that is not to be underestimated, for when publicly listed companies have market capitalizations of up to trillions, a 1% stake represents billions.
Passive minority interests concern those where the minority shareholder owns less than 20% of the company’s equity. This level of ownership gives them no material influence on the company’s decisions. In the corporate world, companies list minority interests on their balance sheet. They also list minority interests on the consolidated income statement representing the share of profits belonging to the minority owners.
The parent company has a controlling interest when it owns 50% to less than 100% in the subsidiary and reports the financial results of the subsidiary consolidated with its own financial statements. In summary, minority interest allows the claims of non-controlling shareholders to be recorded on the consolidated financial statements of the parent company which has a controlling stake. On consolidated financial statements, minority interest allows analysts to distinguish between assets/income belonging to the parent vs. subsidiary. By separating out minority interest line items, financial analysis can better evaluate performance of the consolidated entity vs. its subsidiaries. Under IFRS, however, it can be reported only in the equity section of the balance sheet.
Minority Interest vs Non-Controlling Interest
This adjustment accounts for the total business value, including the non-controlling stakes. A non-controlling interest (NCI) typically occurs when a company owns more than 50% of another company, but less than 100%. Since the first company (parent company) effectively controls the second company (subsidiary company), the parent will fully consolidate the subsidiary’s financials with its own. The income statement approach determines minority interest by attributing a portion of the subsidiary’s net income to minority shareholders based on their ownership percentage.
Valuation of Minority Shareholders’ Equity Stake
This represents the proportion of the subsidiary owned by minority shareholders. Minority interest (non-controlling interest, or NCI) is the proportion of equity or net assets in a subsidiary that is neither directly nor indirectly attributed to a parent. Minority interest represents a percentage of ownership in a company by less than 50% of the outstanding shares with a voting right. Hence, minority shareholders have a little say in a company’s decision-making, and they cannot exert control over the company through voting.
Overview of Primary Valuation Methods for Minority Interest
There are a few common ways to calculate minority interest, which represents the portion of a subsidiary’s equity that is not owned by the parent company. Once a reporting entity concludes that it is appropriate to consolidate another legal entity, the reporting entity must evaluate the accounting for equity instruments that are not owned by the parent. Only equity-classified instruments that are not owned by the parent are noncontrolling interests. For this reason, and to ensure consistency, we need to add minority interest so that the parent does not own back to the Enterprise Value.
If company XYZ owns more than 50% (say 80%) of company ABC, then the financial statements of XYZ reflect all the assets and liabilities of ABC and 100% of the financial performance of ABC. The subsidiary’s assets, liabilities, revenues and expenses are not combined. Instead, the investment is recorded as a single asset on the parent company’s books.