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A Complete Guide on Business Valuation Asset Based Approach

A Complete Guide on Business Valuation Asset Based Approach

jeremiah grant
By - Jeremiah Grant
Last Updated - December 1st, 2022 6:24 AM
Dec 01

Appraisal is a prerequisite for any company to ascertain its true value, and by following the business valuation asset based approach, you can do so in a pragmatic manner. 

Already, companies across the world, notwithstanding their size, are opting for business valuation more often than not. And for good reasons, since a comprehensive company valuation offers an opportunity to not only understand the present position of the firm but also its future potential. 

As such, a business evaluation ascertains your company’s fair market value, helping make realistic projections about your company’s growth and sales. Also, a valuation report comes in handy during stake sales, mergers, acquisitions, internal/external disputes, and more, making it the mainstay of your brand value. 

Now, when it comes to the method of valuing your business, there are three major approaches you can choose from, namely asset-based, market value, and earning approach. And among these three methods of business valuation, the asset-based approach offers a practical and real-time analysis of your company’s assets and liabilities. 

Wondering how the asset-based valuation works to derive the present value of your company? 

Let’s dive right in and have a look. 

What exactly is the business valuation asset based approach?

As the name suggests, the asset-based approach to company valuation involves a detailed assessment of a business’s assets to calculate its total value. Herein, the business appraisal expert you hire will analyze both tangible and intangible assets of your firm and allot a value to each of them. 

First up, the valuation expert will list the tangible assets of your company which includes everything from the property to the building to machinery and equipment to inventory and cash. In short, each physical item that belongs to the firm, no matter its utility, size, or worth, will be listed and assigned a value. 

Second, the intangible assets of the company are also evaluated and assigned value by business valuators. And that includes trademarks, copyrights, and patents that your firm holds, along with the list of clients and consumers and your relationships and goodwill with them. 

In addition to asset assessment and valuation, the expert will also analyze the liabilities of your business, obtaining the fair market value of both. Thereafter, a value is assigned to the company by deducting the total value of liabilities from that of the assets. 

Is this approach worthwhile?

Contrary to the standard earning approach that focuses on a company’s past profits and/or future prospects, the asset-based valuation method keeps the focus on the present-day assets of the business.

This is an effective and highly reliable mechanism to determine the asking price of your company at the time of sale. Also, the data from an asset-based approach valuation report will help you analyze the cost of acquiring another business, buying new assets, or replacing existing ones. 

So a clear picture of a business’s total market worth will help you make more genuine and self-assured deals and offers. 

You might also want to read: Top 10 Reasons for Business Valuation in 2023

Asset-based valuation: How does it work?

Business Valuation Asset-based Approach

You see, the asset-based approach to business valuation considers a company’s assets as the most important factor in generating, sustaining, and growing its revenue. And that’s the reason why the fair market value of its assets is the basis of valuing the company. 

The basic notion of this approach suggests that the total value of a firm’s equity is equal to the total value of its assets (both tangible and intangible) minus the total value of its liabilities (recorded or contingent). 

Within this method of business valuation analysis, valuators like forensic economists and accountants use multiple techniques for valuing an asset, including balance sheet valuation, fair market value, replacement value, and more. 

Coming to the ease of business valuation, it is worth mentioning that the asset-based approach valuation is both simple and complex. 

How? 

The fact that there’s a scope to include non-balance sheet items like a company’s liabilities and contingent assets shows that the business asset valuation approach is quite flexible. Also, it is very simple to estimate the market worth of tangible assets using the book value. 

Nevertheless, calculating the market value of intangible assets can be equally challenging since it requires more data, in-depth analysis, and related expenditures. And as the other approaches don’t include an assessment of intangible assets, they turn out to be more straightforward and less expensive. 

How to do business valuation using the asset-based approach?

Business Valuation Asset-based Approach

An asset-based valuation that relies on the fair market value of a company’s assets is the most frequently used approach by businesses. So it isn’t surprising why business evaluation services relying on this method of asset worth determination on the open market are highly sought after. 

And if you’re curious as to how you can evaluate your firm’s value using its assets, here’s a step-by-step explanation for the same: 

Step #1. Calculate the fair market value of each and every asset that belongs to your company, including the tangible (plant, machinery, etc.) and intangible (trademark, client relationships, etc.). 

Step #2. Deduct the value of all the liabilities from that of the assets, and you’ll get your firm’s net asset value. 

For example, if your business’s total assets are worth $100 million and total liabilities are worth $30 million, its net asset value will be $70 million.

Note: for the above two steps, a calculation of all assets and liabilities, including those that aren’t recorded on the balance sheet, is essential. 

Step #3. You should adjust the net asset value to any extraordinary situation that might prevail or contingency that could be foreseen. Take, for instance, such liabilities on your business that need to be cleared before you can undertake partial or full asset/stake sale. 

Step #4. You can now divide the net asset value adjusted for liabilities by the total number of outstanding shares. As such, you can derive the value of each share of your company. 

What are the methods of an asset-based business valuation?

There are two popular methods in the asset-based valuation approach, namely asset accumulation and excess earnings valuation, that you can use to determine the value of a business. 

Let’s have a close look at how these asset valuation methods work: 

Know the Real Worth of Your Business with Just One Click!

Our business valuation team offers a free 30-minute no-obligation consultation service to understand your needs and issues and provide you with the best solution.

#1. Asset accumulation valuation

The asset accumulation method in asset-based business valuation looks very similar to the famous balance sheet. That’s because the asset accumulation method involves compiling all the assets and liabilities of a firm for the purpose of assigning a value to each of them. 

Therefore, the value of a business, as per this method, is simply the difference between the total value of company assets and liabilities. 

But there’s a catch here. 

Even though this method sounds easy to follow, a valuation expert has to analyze each of the assets and liabilities in great detail. 

Further, the debate that there’s a need for a more effective method of assigning values to individual assets and liabilities is a never-ending one. 

On top of it, some of the items accounted for during the valuation may or may not appear on the company’s balance sheet. And that is despite the similarities often cited between this asset-based valuation method and the firm’s balance sheet. 

The said items mostly include the intangible assets generated internally within a firm, like copyrights, patents, intellectual property, and trade secrets. However, it can also include possible temporary liabilities of a company, like pending legal cases and cost of compliance. 

#2. Excess earnings valuation

The excess earnings valuation method brings together the two models, asset-based and income-based, thus aggregating the information on asset and income. 

If you’re looking for more accurate and trustworthy business valuation data, the excess earnings approach can provide a reliable check against other methods. And that’s why the Internal Revenue Service Rev. Ruling 68-609 suggests using the method in case there’s a lack of evidence for determining the value of intangible assets. 

Just like the standard practice in any asset-based business valuation, the excess earning method also entails a combination of a firm tangible and intangible assets. So it’s the value of both these asset types that are used to evaluate a firm’s overall value.

Nevertheless, apart from analyzing total assets and liabilities and calculating their values, you can even use this method to figure out a company’s goodwill. 

How to determine a business’s goodwill?

You can do so by taking the income of the business as an input and then drawing a connection to the method of earning. In fact, the excess earning model is a highly preferred way of determining how substantial the goodwill is of a strong business. 

As you know, a firm’s goodwill among clients and customers is taken as a strong parameter when evaluating its intangible assets. And with a clear measure of goodwill by following the excess earnings valuation, there’s a good chance that you can aggregate a higher value for your intangible assets. 

Which businesses are an ideal fit for excess earnings valuation?

Since a major focus of this particular method among the twin asset valuation methods is on assigning a value to a firm’s goodwill, it is apt for professional services-based companies.

For instance, businesses like law firms, accounting firms, architectural firms, practitioners of medical and engineering services, etc., can all avail of the excess earnings model. Also, this asset-based valuation method is sure to come in handy for valuing manufacturing companies, technology services providers, and more. 

Business Valuation Asset-based Approach Pros and Cons

 

What are the pros of business valuation asset-based approach?

There are numerous advantages of asset-based business valuation, and the approach is especially useful for companies looking for a partial or total sale. 

Here are some pros of the asset-based valuation method: 

  1. If you’re planning on liquidation, acquisition, or merger, there can’t be a better way of valuing your business than this. That’s because the asset-based approach provides a precise estimate of your firm’s total assets and their individual and combined value. As such, it’s easy to value the company as a whole. 
  2. The method of asset calculation to determine a company’s net worth is the perfect solution for such companies that aren’t profitable now but own a large number of assets. Thus, this approach to valuation is helpful not only for the sale process but also during instances of bankruptcy. 
  3. The asset approach to business valuation considers intangible assets of your firm as well as off-the-balance-sheet items like intellectual property and the company’s goodwill. While these aspects are excluded in approaches like earning or market value, an asset-based valuation includes them to portray the complete information of your business’s value. 
  4. Some valuation methods also factor in a company’s potential for future profitability, something that is highly influenced by the prevailing economic situation. By excluding such factors, an asset-based business valuation keeps your firm’s net value immune from unpredictable economic developments. 

What are the cons of asset-based valuation?

While the fact that the asset approach to business valuation is based on a forensic accounting of assets is appreciable, it isn’t without its shortcomings. And that includes the following:

  1. The fact that this approach overlooks a firm’s future growth potential isn’t desirable since a business model might not be profitable now but can perform par expectations later.
  2. The asset-based method of calculation also ignores present-day earnings and profits of a business. These parameters are considered in other business valuation methods, contributing to an increase in a firm’s overall value.
  3. The process of valuing the intangible assets of a company is a highly sophisticated process. Also, the reliability of intangible asset valuation, which includes putting a value on things like goodwill, is often put into question.

You might also want to read: A Complete Guide To Understand Business Valuation Market Value Approach

Is the selling price of a business the same as its net asset value?

It’s a common belief that the value assigned to a business after a compressive asset-based valuation is the asking price, but it isn’t always the case with firms valued using this approach.

That is so because every valuation expert evaluating a business may value the company more or less differently. Also, buyers looking to acquire a business tend to pay lower than the market value as well as the asking price.

So, even with clear data on a company’s net worth or asset value, it’s always possible that one will buy or sell it at a much lesser price.

You might also want to read: Plant And Equipment Valuation: Why Is It So Important?

Know the Real Worth of Your Business with Just One Click!

Our business valuation team offers a free 30-minute no-obligation consultation service to understand your needs and issues and provide you with the best solution.

Conclusion

You see, there’s not one perfect way to evaluate a business, as every approach or method has its fair share of advantages and flaws. And that is also true for a business valuation that uses the asset-based approach.

Also, businesses will be valued differently using different approaches, so a one-size-fits-all approach is never the ideal solution.

For instance, while one approach can value such a firm favorably, which is profitable in the present day, another can put a high value on a firm with better prospects for the future.

Looking for the right business asset valuation for your company?

You can reach out to us!

At Arrowfish Consulting, we are a team of seasoned forensic accountants and economists with 100+ years of combined experience. So whatever is your operational area or company size, you can count on us.

jeremiah grant

Jeremiah Grant

Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.