The asset based valuation is a valuation method that bases value for a business or investment on the value of assets they possess. This method is mainly applied to an organization whose assets play a significant role in determining the net value. It is important to understand the asset-based analysis for business owners, financial professionals, and investors to gain an accurate view of the business’s net asset value by targeting intangible and tangible assets. In this article, we have explored its advantages, types of valuation, limitations, and how to apply them.
Definition-
- Asset-based valuation is crucial to companies that are asset-based, such as manufacturing, asset-heavy industries, and real estate. It gauges the company value by summing up its assets, which in turn can be tangible assets such as buildings, machinery, and inventory or intangible assets, such as patents, trademarks, and goodwill. This method of valuation is handy for merger and acquisition appraisals, business valuations, and investment analysis.
- The principal idea behind this method of valuation is to estimate the appropriate market value of all the assets that a company owns. It will also deduct the incurred liabilities from the total asset value in order to determine the company’s net asset value (NAV). There are some methods available in the industry for calculating the value of a company.
- The asset-based estimation is usually modified to obtain the net asset value of the company given the current market value of its liabilities and assets. It is way more flexible when it comes to the interpretation of making a choice about which assets and liabilities to include in the valuation purpose.
- The formula that is used in determining the net asset value of a company is:
NAV = Total Asset Value – Total Liabilities
where NAV is the Net Asset Value.
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Purpose Of Asset Based Valuation-
- The basic purpose of such a type of valuation is to find the estimate of the company based on the total value of its assets. It helps creditors, business owners, and investors to calculate the values of the company’s assets that can be used for supporting business finances, business transaction negotiations, or strategic purposes.
- This valuation method can also prove useful when traditional valuation methods such as DCF-the discounted cash flow method or Earnings Multiples may not be applicable or accurate. In several cases, this approach will provide a traditional estimation of the value of a company when its future earning potential is difficult to predict or uncertain.
- Asset-based analysis is typically employed during times of financial distress, acquisition, or other mergers and asset-intensive companies. An enterprise that has heavy investment in tangible assets like mineral resources, manufacturing equipment, or real estate follows this form of valuation.
- This valuation method can also be used by several companies that are facing certain financial difficulties or issues of bankruptcy where the value of liquidation is a critical factor. The asset-based value estimation method is used when the acquiring process of a business is especially done for its assets only and not for its operations or earnings potential.
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Types Of Asset Based Valuation-
The different types of valuation approaches that are commonly used in the industry are explained in the following list. The three major types of valuation that we are discussing here are – Going Concern Approach, Liquidation Approach, and Replacement Value Approach. Each of these methods is suitable for different business scenarios and they provide a different perspective on the company’s value based on its assets.
- The Liquidation Approach assumes that the company will stop its operations and will sell off its assets individually. This valuation method calculates the value of the assets based on how much amount they will get during the situation of a forced sale or orderly liquidation of the assets. The valuation generally reflects the discounted value of an asset since they are sold in a liquidation at lower prices. It is useful for business stakeholders like creditors and bankruptcy courts to evaluate the recovery value of the company’s assets during a business failure.
The liquidation approach is most suitable for those companies that are going through financial distress, facing bankruptcy, or when a decision has been made to close down the business. It is also used during situations when a quick sale of assets is required and that money is in turn utilized for paying off the creditors. This approach is a traditional one and mostly offers a lower valuation of the assets.
2. Another type of valuation approach is the Going Concern Approach. In this approach, an assumption is made that the company will continue to operate indefinitely in the future. This method values the company’s assets based on their contribution to the operations of the business rather than their potential selling price in a business liquidation situation.
It focuses on the fair market value of the company’s assets since these assets are used in the business at present. This approach is mainly used among those companies that are profitable or are expected to stay operational in the future. It is suitable for businesses where their assets are essential in generating revenues and profits for the company.
This valuation approach provides a much better and practical valuation for businesses that are expected to continue their operations. It typically reflects the value of the company’s assets as a part of its operational business entity. It can generate a higher valuation result when compared to the liquidation approach since it considers the earning potential of the assets.
3. The last type of valuation approach in our list is the Replacement Value Approach. It calculates the cost of money that is required to replace the assets of a company with equivalent or similar assets at the present market value. It will consider the price of acquiring new assets, its installation procedure, transportation costs, and other associated costs that are required to make the newly acquired asset into an operational one.
This type of valuation approach is useful for valuing those companies that have implemented a considerable amount of investments in equipment, infrastructure, or machinery. It is because this approach takes into account the current price of replacing the assets and not their book value or historical costs.
This approach might produce a result of higher valuation than the liquidation approach since it assumes that the assets of the company can be replaced at the present market value and not sold off at a discount rate.
Selecting The Suitable Valuation Approach-
- The selection of a suitable valuation approach depends on different factors like the company’s current financial situation, the nature of its assets, and its prospects. All the approaches provide valuable insight into the asset value of a company. However, they are used for specific business financial situations. A valuation usually considers all the approaches depending on the purpose of the valuation and the special circumstances of the business.
- The liquidation approach is used for those companies that are shutting down, facing insolvency, or have uncertainty about their future operations. The going concern approach is suitable for a stable or growing business where the assets are majorly used to generate income. The replacement value approach is used when valuing assets with replacement costs or for calculating the cost to replicate the unique abilities of money-intensive industries.
Advantages And Disadvantages Of Asset Based Valuation-
The advantages of the asset-based analysis are explained in the following section:
- One of the main advantages is that this valuation is suitable for liquidation business scenarios. It can value companies that are facing liquidation or in distress situations. It provides a clear view of what shareholders can expect if the company is sold off or liquidated.
- It has the characteristics of simplicity and objectivity. It is usually easy to calculate, especially for companies with significant tangible assets. The value is based on the liabilities and assets recorded on the balance sheet, making it more objective and less exposed to subjective arrangement.
- It will reflect the replacement costs of assets that are very important for those companies in the industries where asset replacement is a significant factor of costs. It can also provide a foundation for evaluating the cost required to replicate the asset of a company.
- It will provide a more accurate value for those businesses that have considerable amounts of tangible assets like utilities, real estate, or manufacturing. It is appropriate for asset-intensive businesses that do not depend heavily on the intangible assets or future growth potential of the business.
- This asset-based analysis is useful for benchmarking against industry standards or other companies with similar asset bases. It enables comparisons based on tangible assets rather than earnings which can be volatile.
The list of disadvantages incurred by the asset-based analysis is explored in the following section:
- This valuation might undervalue the companies with intangible assets. This method can result in an undervaluation for those companies that depend on intangible assets like technology firms or service-based businesses. Typically, the intangible assets are not entirely recorded on the balance sheet and it is challenging to quantify them accurately.
- This asset based valuation ignored the future earning potential and growth prospects of the company. This is a significant drawback for different types of companies operating in the growth sectors or for those companies that have intangible assets like brand value, intellectual property, or customer relationships.
- Another potential disadvantage is that they might overlook the liabilities. In some cases, this valuation might not fully account for all liabilities like contingent liabilities or off-balance-sheet items. This will lead to an overvaluation of the net assets of the company.
- This approach is not suitable for all industries. Several industries do not have noteworthy physical assets like software companies or consulting firms. In these situations, this valuation may not provide an accurate result of the value of those businesses that generate value mainly from intellectual capital or innovative abilities.
- The value resulting from this asset based valuation approach is dependent on the accounting practices and the methods that are used to value the assets. Different types of depreciation methods, historical cost accounting, or differences in asset valuations will affect the accuracy and comparability of the valuation outcome.
- The value of assets might not accurately show their current market value particularly if the assets have depreciated immensely or are outdated. This might result in an exaggerated valuation outcome if the asset’s values are not regularly updated or reappraised.
Step-By-Step Guide to Conduct an Asset Based Valuation-
Below we have given a step-by-step guide to performing an asset based valuation on your company.
- The first step is to gather all the available financial statements and relevant information. Collect all the most recent balance sheets and additional financial documents. Also, understand the nature of the business and the type of assets that it holds (like tangible assets or intangible assets)
- Now, identify and categorize the assets of the company. List all the assets recorded in the balance sheet including both current assets and non-current assets. To provide an accurate evaluation of the asset’s value, assess the condition and relevance of each asset.
- In this step, determine the appropriate valuation method for each type of asset. Some of the methods are market value, replacement cost, net realizable value, and book value. Perform the reassessment and adjustment for the value of assets that might be undervalued or overvalued in the balance sheet.
- Identify and value liabilities by listing all liabilities on the balance sheet. The liabilities can be current and non-current liabilities. Now, evaluate the accuracy of liabilities that are recorded on the balance sheet and consider any off-balance-sheet items.
- Calculate the net asset value (NAV) by subtracting the total liabilities of the company from the total assets in a business. Ensure that all the valuations are up-to-date and show the market conditions.
- Make essential adjustments to the intangible assets and liabilities. Assess the value of intangible assets (by valuing them separately) and adjust the contingent liabilities or off-the-balance sheet items.
- Conduct a sensitivity analysis to understand how changes in assumptions will impact the valuation outcome. This will help in understanding the power of the valuation and the potential impact of different scenarios.
- Next, review the entire valuation process to ensure that all assets and liabilities have been accurately valued. Validate the methodologies and assumptions in the valuation. To perform this process, you can also consult third-party financial experts or auditors.
- In this step, prepare a comprehensive valuation report that summarizes the results of an asset based valuation (including all assumptions, methodologies, and findings). Present these results to the stakeholders like management, investors, or potential buyers based on the purpose of the valuation.
- The final step is to update the asset-based analysis regularly to incorporate the changes in the market conditions, business strategies, or the company’s assets. It is also advised to reassess the valuation periodically to make sure that it reflects the current situation of the company accurately.
Conclusion-
The asset based valuation is a methodology that is used to determine the company’s net value based on the asset’s value. It helps the companies to perform the valuation easily and is suitable for companies that have tangible assets or those facing financial downturns. Different types of valuation are the liquidation value approach, the going concern value approach, and the replacement value approach. Each of these approaches has its unique benefits and limitations, and these can be used according to the situations of the companies that are being valued. The asset-based analysis involves different steps in its due valuation. It is essential to understand and follow these step-by-step guides to get better and more accurate valuation results.
FAQs-
1. Which types of companies will benefit from the asset based valuation?
The companies that benefit most from this valuation are those with tangible assets. Some of the major companies that come under this category are listed below:
- Manufacturing companies with considerable machinery and equipment
- Utilities and infrastructure companies with vast amounts of physical assets
- Real estate firms with a large portfolio of properties
- Financial institutions with significant amounts of financial assets
2. How can we value the intangible assets in the asset based evaluation methodology?
Valuing procedures for intangible assets like trademarks, goodwill, customer relationships, and patents are challenging. However, several methods can be utilized to make this valuation properly. They are:
- The Income Approach involves discounting the future income resources that are related to the intangible assets to the present value
- Market Approach is done by comparing the present market value of the similar intangible assets involved in the company
- The Cost Approach estimates the cost required to recreate the intangible assets of a company
3. Can we use this asset based analysis for the newly emerged startup businesses?
The asset-based evaluation methodology is generally not suitable for startup businesses. Startups will have only a few tangible assets and they mostly depend on intangible assets (like intellectual property, growth potential, and market opportunities). Several valuation methods like the discounted cash flow analysis or comparable company analysis will be more suitable for startup companies.
4. How frequently should we update this valuation procedure?
The frequency of updating the valuation mostly depends on the purpose for which you have conducted the valuation. If you have an ongoing business with continuous operations then perform an annual review. Meanwhile, if you have a business that is undergoing notable changes, mergers, acquisitions, or liquidation, then it will require more frequent updates to reflect the present condition of the market.
5. Can we combine this valuation methodology with other valuation methods?
Yes, it can be combined with other valuation methods such as the discounted cash flow (DCF) or market multiples methods. It is done to provide a more thorough perspective of the value of a company. This combined approach will also help to balance the strengths and weaknesses incurred by different valuation methods.
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