An asset-based approach is a type of business valuation that focuses on a company’s net asset value. The net asset value is identified by subtracting total liabilities from total assets. There is some room for interpretation in terms of deciding which of the company’s assets and liabilities to include in the valuation and how to measure the worth of each.
Asset-based valuation is a form of valuation in business that focuses on the value of a company’s assets or the fair market value of its total assets after deducting liabilities. Assets are evaluated, and the fair market value is obtained.
Identifying and maintaining awareness of the value of a company is an important responsibility for financial executives. Overall, stakeholder and investor returns increase when a company’s value increases, and vice versa.
There are a few different ways to identify a company’s value. Two of the most common are the equity value and enterprise value. The asset-based approach can also be used in conjunction with these two methods or as a standalone valuation. Both equity value and enterprise value require the use of equity in the calculation. If a company does not have equity, analysts may use the asset-based valuation as an alternative.
Many stakeholders will also calculate the asset-based value and use it comprehensively in valuation comparisons. The asset-based value may also be required for private companies in certain types of analysis as added due diligence. Furthermore, the asset-based value can also be an important consideration when a company is planning a sale or liquidation.
Going Concern is the approach to asset-based valuation methods for a company that expects to continue operating and growing. After referring to the balance sheet, negotiations will likely focus on the assumed value of those intangible assets.
Liquidation is the approach to asset-based valuation methods for a company that is closing and liquidating its assets. This is an important distinction from the Going Concern approach because the liquidation value of assets is typically below fair market value.
Asset-based Valuation Methods
- Excess Earnings Valuation
On the other hand, the excess earnings approach is a combination of the income and assets valuation methods. Other than evaluating a company’s tangible assets and liabilities, the method can also be used to work out a business’s goodwill.
To determine goodwill, the earnings of a business are treated like input, and then a connection is drawn to the income method. As a result, the excess earnings method is highly preferred when valuing strong businesses with substantial goodwill.
Typical examples include businesses that offer professional services like accounting and law firms, engineering and medical practices, as well as architectural firms. The excess earnings method is also useful during the valuation of manufacturing enterprises and well-established technology companies.
- Asset Accumulation Valuation
The asset accumulation method bears a striking superficial similarity to the widely known balance sheet. In the asset accumulation method, all the assets and liabilities of a business are compiled, and a value is assigned to each one. The value of an entity is the difference between the value of its assets and liabilities.
As simple as it sounds, as always, the burden lies in the details. Each asset and liability must be identified carefully. In addition, the asset accumulation method requires an effective way of assigning values to assets and liabilities.
A few of the items typically used during valuation don’t always appear on a standard balance sheet. They include internally generated intangible assets like trademarks, patents, as well as trade secrets. The list also contains provisional liabilities, which may comprise compliance costs or unresolved legal cases.
Business Value vs. Selling Price
The selling price of a business and its value are not the same. The reason businesses conduct asset-based valuation is to find out what an entity would go for, theoretically speaking. However, practically speaking, the value of an entity varies, based on the person doing the valuation.
So, an overexcited buyer looking to replace losses can choose to pay a substantial sum just to acquire a business. Financial buyers tend to pay quite low when acquiring a business.
There is also market exposure, which plays a significant part as well. Pitching the business to potential buyers is only half the task when looking to achieve the best price.
The asset-based valuation approach is the generally accepted method for valuing a company. An analyst looks at four factors when valuing a business:
- The company’s business interests
Business interests can also affect valuation. The asset-based approach is used to value the overall business and is usually performed during the purchase or sale of the business, or a merger or acquisition. It is also used when the price of the business is directly related to its tangible and intangible assets and not the value of its stock.
- Type of company
With regard to the type of company, the asset-based approach can be used by companies that own both tangible and intangible assets. Therefore, the valuation can be used for asset holding companies and asset operating companies. Virtually all businesses fall into one of these two categories.
- Availability of data
Lastly, the amount of information available can also affect an analyst’s ability to use this valuation approach. If there is no access to asset-specific information or if there’s been a substantial change(s) in the value of tangible or intangible assets since their valuation date, it can impede the analyst’s ability to use the method.
- Types of transactions in the business
The asset-based valuation method is used for taxable transactions to secure financing, as various creditors place a different value on the assets of the business.