Asset Based Valuation Methods

By Ravish kumar - April 24, 2018


Asset Based Valuation Methods

Asset based valuation methods are utilized to determine the value or worth of a business. The asset approach is defined in the International Glossary of Business Valuation Terms as “a general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilities.” 

Asset based valuations are based on the principle of substitution. Accordingly, a buyer would not pay more than the cost to build a similar property.

Asset Based Valuation Methods

Let us understand the main methods involved in Asset based Valuation

Book value method

Equity of a business is determined by subtracting the book value of the liabilities from the book value of the assets.

The book value of most assets is based on historical cost deducting accumulated depreciation. These amounts are not reflective of current value and not useful for buyer or seller. Liabilities are recorded at the present value of the liability using rates at the time the liability is established and are not modified to indicate market changes.

Adjusted net asset method or Asset accumulation valuation method

Adjusted net asset is an asset-oriented approach. It establishes a “floor value” for estimating total entity value. All the assets and liabilities of the balance sheet are identified. The off- balance sheet items such as internally generated intangible assets, strategic partnership agreements, pending legal judgments, contingent liabilities, and property and income tax obligations are also identified and their effect on valuation is considered.  Adjusted net asset is determined by subtracting the fair market value of the liabilities from the fair market value of the assets. The assets and liabilities are restated to their fair market value.
Based on the unique conditions and purpose of the valuation, it utilizes the replacement, liquidation or going concern premises of value of the company’s assets less the liabilities.
  • Liquidation value:  fair value of an asset is estimated on sale, liquidation or closure.
  • Replacement value:  based on current replacement value of the business, estimating price to recreate the business utilizing current construction costs and standards.
  • Going concern:  fair value of an asset is determined assuming business will operate indefinitely.

The net asset value is also referred as the total equity value. The equity value can be adjusted to conclude the value of the invested capital (i.e., long-term debt plus total equity) or to conclude the value of one class of equity (e.g., voting common stock).

The valuation is generally concluded on a marketable, controlling ownership interest level of value.  To the extent that another level of value is appropriate for the valuation assignment (e.g., a nonmarketable, noncontrolling level of value), then appropriate valuation adjustments including discount for lack of control and marketability should be applied.

Adjusted net asset method is a balance sheet-based approach to valuation that is suitable especially for non-operating business, holding companies, capital-intensive companies and companies generating losses.
The disadvantage of this method is that it disregards business’s operating earnings. It is not appropriate to value intangible assets including patents or copyrights which are based on operating earnings. However, replacement cost method may be used in estimating values of intangibles such as patents.

Capitalized excess earnings method

Excess earnings method estimates the earnings of net tangible assets. Excess earnings are calculated by subtracting earnings of net tangible assets from total earnings. The value of intangible assets is estimated by dividing excess earnings by capitalization rate. The total business value is estimated by adding the value of net tangible assets to intangible assets.

Excess Earnings Method is especially used in professional services, manufacturing and technology firms. The method is also utilized in valuations for divorce. It is used to determine the value of business goodwill.

Conclusion

Most commonly employed asset-based valuation method is adjusted net asset.

Asset based valuation is often utilized when a company preparing for liquidation and when the business is based on assets, and not on income. The asset-based valuation should be used in the valuation of closely held businesses, business ownership interests, and securities performed for transaction, taxation, litigation, financial accounting, financing, bankruptcy, or planning purposes. Asset based valuations may be of limited use in a hyper-inflationary environment.

We at Veristrat have the required skills and expertise to perform asset based valuations utilizing book value, adjusted net asset and capitalized excess earnings methods. Our in-house experts provide high-quality asset based valuations to our clients.



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