Asset-Based Valuation Approach

Understand

Asset-based valuation approach is one method of business valuation along with income based and cash flow based approaches. In which, to determine the value of a company, the fair value of its total assets is excluded from its total liabilities. This approach utilizes book of accounts of the company for the book value of assets and often utilizes when the company is about to liquidate or no longer operational as going concern.

Explanation

The value of company’s assets can be calculated by following ways:
The book value of assets is the value based on company’s books of accounts, this method is used very little because depreciation element may prematurely underestimate or value above real worth of assets. For example, an asset purchased 5 years before has been written down by depreciation to $120, however, its current worth now in the market is $190. The difference of $70 is because the depreciation element has written down the value prematurely.
Replacement value method is used when assets are going to use as going concern and their value is the cost of replacing these assets.
Break-up value / Net realized value is the best price obtainable, which depends on the market and urgency of parties.
Asset-based valuation approach is useful for capital intensive nature business whereas labor intensive business will get undervalued by using this approach.

Advantages

This method is easy to calculate, readily available and provide a minimum value of the company.

Disadvantages

–  Valuation of intangible assets is difficult such as intellectual property rights.
–  Company’s future earnings are ignored.
–  The statement of financial position may prematurely value assets because of depreciation element.

Formula

Asset-based valuation = Fair value of company’s total assets – its total liabilities
Where total assets include both tangible and intangible assets, the value of tangible assets is taken from company’s balance sheet whereas intangible assets are calculated by using calculated intangible value (CIV) method or by simple estimate.
For example, you own a company, which has total tangible assets of $1000 and liabilities of $420. Using asset based valuation approach; your company will value $580 after excluding liabilities of $420.

Next: How to calculate the value of intangible assets?

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