At Unbroker, we know that understanding business valuation is crucial for making informed financial decisions. The asset approach to business valuation is a powerful method that focuses on a company’s tangible and intangible assets.
In this post, we’ll break down the key steps of asset-based valuation and explore its advantages and limitations. Whether you’re a business owner or investor, you’ll gain practical insights to help you navigate the complex world of business valuation.
What Is the Asset Approach?
Defining the Asset Approach
The asset-based approach identifies a company’s net assets by subtracting liabilities from assets. This method provides a snapshot of what the business would be worth if all its assets were sold and all its debts paid today. It’s particularly useful for asset-heavy businesses (such as real estate companies or manufacturers).
Types of Assets in Valuation
The asset approach considers both tangible and intangible assets:
- Tangible Assets: These include cash, inventory, equipment, and real estate.
- Intangible Assets: While harder to value, these are equally important and can include patents, trademarks, and customer relationships.
A 2020 study by Ocean Tomo found that intangible assets now account for 90% of the S&P 500’s total assets, up from just 17% in 1975. This shift underscores the importance of properly valuing intangible assets in modern business valuations.
When to Use the Asset Approach
The asset approach is most effective in specific scenarios:
- Asset-Intensive Businesses: Companies with significant physical assets benefit from this method.
- Non-Operating Concerns: It’s ideal for businesses that are no longer operating as going concerns.
- Liquidation Purposes: This approach provides a clear picture of what creditors might recover.
However, this method has limitations. It doesn’t account for a company’s earning potential or market position, which can be critical factors in determining true value. KPMG’s research shows that investments with a balanced approach to value creation achieve 15 percent EBITDA growth.
Limitations of the Asset Approach
- Ignores Future Earnings: This method doesn’t consider a company’s potential for future growth and profitability.
- Undervaluation Risk: For businesses with significant intangible assets or strong market positions, the asset approach might underestimate their true worth.
- Complexity in Valuing Intangibles: Assigning accurate values to intangible assets can be challenging and subjective.
The asset approach offers a straightforward valuation method, but it’s not always the best fit. For a comprehensive valuation that considers all aspects of your business, it’s advisable to consult with experts who can guide you through various valuation methods. (If you’re considering selling your business, platforms like Unbroker can provide valuable insights and support throughout the process.)
How to Execute Asset-Based Valuation
Asset-based valuation requires a systematic approach and a deep understanding of your business’s financial landscape. This method involves four key steps that will help you determine your company’s value based on its assets.
Comprehensive Asset Identification
The first step is to create an exhaustive list of all assets. This process extends beyond your balance sheet. Include tangible assets like cash, inventory, and equipment, but don’t overlook intangible assets such as patents, trademarks, and customer lists. A study aimed to provide a better understanding of the relative financial statement impact of digital asset and intellectual property losses, highlighting the importance of intangible assets.
Accurate Fair Market Value Assessment
After you identify all assets, determine their fair market value. This task isn’t always straightforward. For tangible assets, you might need professional appraisals. For intangibles, consider methods like the relief from royalty approach or the excess earnings method. The International Valuation Standards Council provides guidelines for valuing intangible assets, with the purpose of promoting and maintaining a high level of public trust in valuation practice.
Thorough Liability Calculation
Calculate your total liabilities next. This includes both current and long-term liabilities. Don’t forget off-balance sheet items like operating leases or pending lawsuits. A comprehensive review of all liabilities is crucial for an accurate valuation.
Net Asset Value Computation
Subtract your total liabilities from your total asset value to obtain your business’s net asset value. This figure represents the theoretical value of your business if you liquidated all assets and paid off all debts today.
The asset-based approach provides valuable insights, but it’s just one piece of the valuation puzzle. For a holistic view of your business’s worth, consider combining this method with income-based or market-based approaches. Expert guidance through the valuation process can help you navigate these complexities and ensure a thorough and accurate assessment of your business’s value.
Is the Asset Approach Right for Your Business?
Strengths of Asset-Based Valuation
The asset approach to business valuation provides a clear, tangible picture of a company’s worth. This method works best for businesses with significant physical assets, such as manufacturing companies or real estate firms. PwC’s guide addresses various topics including the accounting for asset acquisitions and asset retirement obligations.
Asset-based valuation also offers objectivity. Unlike methods that rely on future projections, this approach focuses on present, verifiable values. This proves especially valuable in situations like divorce proceedings or estate planning, where a straightforward, defensible valuation is necessary.
Challenges and Limitations
Despite its strengths, the asset approach has limitations. It tends to undervalue businesses with strong growth potential or significant intangible assets. A 2022 Interbrand report revealed that for the world’s top 100 brands, the average value topped US$3 trillion, with intangible assets ranging from 65 to 85% of total company value.
The method also fails to account for a company’s earning potential. This can lead to severe undervaluation, especially for service-based businesses or tech startups where future earnings far outweigh current asset values.
Comparing Valuation Methods
When deciding on a valuation method, consider your business type and valuation goals. While the asset approach works well for asset-heavy businesses or in liquidation scenarios, other methods might suit different contexts better.
The income approach often suits businesses with strong cash flows and growth potential. It considers future earnings, making it ideal for service-based companies or those with significant intangible assets.
The market approach compares your business to similar sold companies, providing valuable insights in industries with frequent transactions. However, it requires access to reliable market data, which isn’t always available for private companies.
Choosing the Right Approach
A holistic approach to valuation often yields the most comprehensive understanding of your business’s worth. Combining elements from different methods can help achieve more accurate valuations.
The right valuation method can significantly impact your business decisions (whether you’re planning for a sale, seeking investment, or simply want to understand your company’s position in the market). While the asset approach has its place, consider all options and seek expert advice to ensure you’re using the most appropriate method for your unique situation.
Final Thoughts
The asset approach to business valuation offers a clear snapshot of a company’s worth, especially for asset-intensive businesses. This method focuses on tangible and intangible assets, providing a solid foundation for understanding current value. However, it may not capture future growth potential or fully value intangible assets, which limits its effectiveness for some businesses.
Professional appraisers or valuation experts can ensure accuracy and compliance with industry standards when implementing the asset approach business valuation. They can also help combine this method with other valuation techniques to provide a more comprehensive picture of a business’s true worth. This holistic approach proves particularly important for businesses with significant growth prospects or those in rapidly evolving industries.
Unbroker understands the complexities of business valuation and sale. Our platform offers transparent, cost-effective solutions for selling businesses, eliminating high brokerage fees while providing expert support. Whether you prefer a hands-off approach or want to take an active role in the sale process, Unbroker’s services can help you navigate the challenges of business valuation and achieve a successful sale.
