Asset-Based Approach

Valuation of a company considers its assets through the asset-based approach.

What Is the Asset-Based Approach?

The asset-based approach takes into account the company’s assets for valuation. The fair market value is most frequently used in these processes. The primary determinant of fair market value under this approach is the current value of a company’s tangible net assets. This strategy is often employed when a company is not a going concern. In case it is a going concern, this approach is applied only when its worth is strongly correlated with the liquidation value of the underlying investments and tangible assets. 

Asset Valuation Approaches

Let’s discuss the numerous techniques that make up the asset-based approach to business valuation.

Asset Accumulation

The first approach is known as the asset accumulation approach and is quite similar to the well-known balance sheet valuation. This strategy involves compiling a company’s assets and liabilities and assigning a value to each. The difference between the company’s asset and liability values represents the company’s value in this instance. Although it seems quite straightforward, the devil is in the details.

Each asset and liability must be carefully identified. The asset accumulation approach also needs a reliable system for giving each asset and liability a value. Additionally, some items utilized in business valuations do not usually show up on typical balance sheets. They consist of internally created intangible assets like trade secrets, patents and trademarks. Provisional liabilities, which generally consist of unresolved legal matters or compliance expenses, are also included in this list.

Excess Earning Valuation

Excess earnings valuation is the second type of asset-based firm valuation technique. This method combines the asset-based valuation method and the income-based valuation method. By using this methodology, we assess the company’s goodwill as well as its tangible assets and liabilities. The earnings of the businesses are used as input to calculate the company’s goodwill, and a link is subsequently made to the income method.

But keep in mind that a business’s value and selling price are never the same. This is better explained in the next section.

Selling Price vs Business Value

A company’s value and its selling price are not equivalent. The goal of asset-based valuation, which is used by many firms, is to determine what an entity would theoretically sell for. However, depending on who is making the valuation, the worth of the entity fluctuates. 

The Challenge

Adjusting net assets is one of the most difficult aspects of doing an asset-based valuation. Identifying the market worth of assets in the current environment is the goal of an adjusted asset-based valuation. Depreciation is used in the balance sheet to reduce the value of assets over time. As a result, an asset’s book value may not always be the same as its fair market value.

Some intangibles that are either not fully or even partially valued on the balance sheet may be taken into account for net asset adjustments. Certain trade assets may not need to be valued by businesses. However, these intangibles are crucial to take into account since an asset-based method examines the prospective sale price of a company in the current market.

Liabilities can also be adjusted in a calculation of adjusted net assets. Market value adjustments could possibly raise or lower the value of liabilities, which has a direct impact on how net assets are determined.