Asset Based Valuation – Asset Approach

What is the asset-based approach?

The asset-based approach is a type of business valuation based on a company’s net asset value. It is calculated by subtracting total liabilities from total assets. For an asset-based valuation to show the fair market value of a business, it is necessary to use the market value of the assets and liabilities, rather than the book value.

When is Asset Based Valuation used?

• An asset approach valuation is useful for valuing asset-heavy businesses, such as companies with a lot of expensive machinery or equipment, holding companies, investment companies, or real estate companies.
• It can be used when other methods are not applicable, such as when there is no profit and cash flows are unpredictable.
• The asset method is often used to value distressed businesses and businesses in liquidation.
• Because it is based on the fair value of assets and liabilities, it does not require complex projections or assumptions about future performance, making it a straightforward valuation method.
• The method is often used in conjunction with the income approach, which is based on the company’s earnings or cash flow. This is often the case for sales of businesses, mergers and acquisitions.
• Sometimes the method is used in conjunction with the market approach, which looks at what similar businesses are selling for in the marketplace.

The Asset Based Approach – Step by step

A company’s net asset value is equal to its assets minus its liabilities. In its simplest form, this is the “equity” on the balance sheet.

However, the value of assets on the balance sheet is reduced over time by depreciation. The true market value of assets can often be higher than their book value, but sometimes it can be lower.

Therefore, the assets, at least the most important ones, have to be adjusted before calculating the net asset value of the company.

In theory, the same applies to liabilities, although adjustments to liabilities are less common.

Let us show you how the assets-based approach can be applied in practice.              

How to do an asset based approach valuation:

1. Start with the balance sheet to identify the company’s assets and liabilities.
2. Often there are valuable intangible assets that are not on the balance sheet but may be important to include, especially if the business is to be sold. Examples include trademarks, patents or brands.
3. Make an asset valuation to assess the market value of each asset. Adjust the balance sheet accordingly.
4. Look at the liabilities and make adjustments as needed. For example, if there are off-balance sheet liabilities, contingent liabilities such as lawsuits or guarantees, debt restructuring, or the like.
5. Finally, subtract the liabilities from the assets. The result is the net asset value of the company.

Pros and Cons of Business Valuations with the Asset Approach

The appeal of asset-based valuation lies in its simplicity. Both assets and liabilities are often easy to identify from the balance sheet. It is a quick way to calculate the value of a business without having to use advanced formulas or make bold assumptions or projections.

However, it is easy to underestimate the work that goes into an asset-based business valuation. Simply using the book value found on the balance sheet is usually misleading. Assets and liabilities need to be adjusted before the value is calculated, especially assets.

The Asset Approach Ignores Income

The method does not take into account the earnings, growth or potential of the business. It often does not even take into account intangible assets, although that is up to the business appraiser to decide. And when it does, determining the value of intangible assets is often a complicated task.

In some cases, the asset approach is useful as the sole valuation method. For example, when you need to know an approximate minimum price for a business quickly, or to calculate the value of a business that will be liquidated.

Combine It With Other Methods!

However, the full potential of the asset method lies in its combination with other valuation methods. In combination with the income approach, it becomes truly powerful in showing the fair value of a business.