Starting our series of articles off we looked at the cases when business valuations may be necessary, and the possible methods, then we conducted a thorough analysis of the features of income-based methods and comparables methods; in this article we are going to present the asset value methods.
What are asset value methods based on?
Asset value methods characteristically draw on historical data from financial statements. According to this method, the value of company can be determined as the difference between the carrying value of its assets and its liabilities.
What asset value methods are there?
Asset value methods can essentially be divided into two categories:
- Valuation based on going concern principle
- Use of liquidation value
If we assume the going concern principle, assets can be valued at their carrying value or at the asset value adjusted to market value, thereby identifying any hidden reserves. In this case, the data of the company’s financial statements can be taken as the basis for assessing the values of assets and liabilities. A typical example of hidden reserves is a real estate purchased many years ago, where its market value may be much higher than its carrying value in the books according to an independent property appraiser’s evaluation.
The liquidation value is applied when the company’s owners do not want to or the company is incapable of continuing its operations, and therefore the owners are forced to sell the company’s assets to meet their obligations to creditors and pay other liabilities from the sales revenue. In the majority of such cases the liquidator generally has to define a value far below the market value, a so-called salvage value, to be able to turn the assets of the company into cash. So a valuation based on the liquidation value usually results in a lower figure for the company than a valuation based on the going concern principle.
What is the problem with asset values?
The same asset may have different carrying values based on the accounting system used (for example IFRS or the Hungarian Act on Accounting), and the application of the options provided by the given system. So it is easy to see that asset value methods may be significantly influenced by the accounting valuation methods chosen by the company. At this point, revaluation using the buyer’s valuation methods becomes a possibility with a view to obtaining a more relevant figure.
Furthermore, we can try to identify hidden reserves among the assets, i.e. differences between the market value and the carrying value of assets, during which the assets and liabilities are valued at their market value instead of their carrying value. Defining market value, however, is a much more complex process than valuations based on carrying value. An appraiser might be needed to assess market value. The market value of assets can typically be defined by finding comparable prices or assessing the replacement costs.
When defining the carrying value of assets adjusted to market value, it is also possible to include assets during the identification of hidden reserves which were not included in the financial statements, such as goodwill and clientele. The goodwill mentioned above, which is designed to show how much more a company is worth than just the simple mathematical difference between its assets and liabilities, needs to be defined using a different business valuation method, the income-based method. This is how mixed valuation methods are formed.
What is the significance of the method?
From all the values of a company, asset value gives the minimum figure since each company’s value is equivalent to at least the value of its assets less the amount necessary to meet the company’s liabilities. One of the advantages is that the carrying value of assets can be retrieved very simply from published financial statements.
What are the drawbacks of asset value methods?
The weaknesses of the method are as follows:
- This valuation does not take into account the future potential of the company.
- It does not consider the company’s strategies for the future.
- It can be influenced by measurement methods.
- When adjusting to market value an appraiser needs to be involved in the process.
- Identifying and valuing assets not included in the books – such as goodwill – is a very complex and time-consuming task.
Asset value methods are useful because they are simple. They are important because they define the minimum level of a company’s value.
If you have questions about business valuations, please contact our financial consulting experts!