Asset based approach
| Asset based approach |
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| See also |
The asset-based approach is also commonly known as the cost approach or the replacement cost approach. In this approach, each part of the business is valued separately. This also includes liabilities. The asset values are summed up, and the total of the liabilities is subtracted to derive the value of the company. The valuation analyst estimates value by adjusting the asset values of the individual assets and liabilities of the company to fair market value. Some valuation analysts will use this method for tangible assets only and consider it to be complete. This approach, like the market and income approaches, is intended to value the whole company. This means that the tangible assets, as well as the intangible assets, are to be valued and the liabilities subtracted. When using only this approach to value a company, it is not difficult to overstate the value of the business as a going concern because if there are insufficient earnings to support the asset base value under this approach will be higher than the other approaches[1].
Of the three approaches to valuation, the asset-based approach is considered to be the weakest from a conceptual standpoint for valuing an ongoing business. The asset-based approach is used infrequently for the valuation of going concerns, reasons include the limited market data available to directly value intangible assets, difficulties in valuing certain tangible assets (such as special-use equipment), and the more readily available information to value operating companies as an integrated whole rather than on an asset-by-asset basis. An operating company with nominal profits relative to the values of assets used and without prospects for improvement in the future might best be valued using an asset-based approach assuming the winding up of operations. In this particular case, its value as a going concern might be less than its value in liquidation because the assets might be redeployed by buyers to higher-valued uses. Resource and financial businesses might also be valued based on an asset-based approach. Banks and finance companies largely consist of loan and securities portfolios that can be priced based on market variables. In such cases, a total of individual asset value estimates may give a lower-bound-type estimate of the overall value of the company[2].
Common applications for the asset-based approach
The asset-based approach is most commonly used in the following types of business valuations[3]:
- Not-for-profit organisations
- Holding companies
- Manufacturing companies
- Asset intensive companies
- Controlling interests that can liquidate assets
Advantages of asset-based approach
The most important advantages of asset-based approach are [4]:
- Net tangible assets can be valued more genuine under this approach than under the other two
- This approach creates a better reflection of the economic balance sheet of the subject company
- Net tangible assets can generally be seen and felt, giving the user of the appraisal a "warmer" feeling about the value
Disadvantages of asset-based approach
On the other hand, there are also some downsides to using this method [5]:
- This approach is most readily applicable only to tangible assets
- The asset-based approach provides the valuation analyst with the cost of duplicating the business being appraised
- This approach is frequently more time consuming, and sometimes costly to apply than the other approaches
Examples of Asset based approach
- Property, Plant, and Equipment: This refers to the physical assets of a business, such as land, buildings, machinery, and equipment. These assets are valued based on their original cost, less any depreciation.
- Intangible Assets: These are non-physical assets such as customer relationships, patents, and trademarks. These assets are valued based on their estimated fair market value.
- Financial Assets: These are assets such as investments, cash, and accounts receivable. These assets are valued based on their current market value.
- Liabilities: These are debts or obligations that must be paid. They are valued based on their estimated fair market value.
The asset-based approach is one of the main methods used to value a company. However, there are other approaches related to the asset-based approach that are also used. These include:
- The Market Approach: This approach is used to compare the selling prices of similar assets to the assets of the company being valued.
- The Income Approach: This approach is based on the premise that the value of an asset is equal to the present value of the future benefits it will generate.
- The Comparable Transaction Approach: This approach uses the financial information of similar companies that have recently been sold to value the target company.
In summary, the asset-based approach is one of the main methods used to value a company. However, there are other related approaches such as the market, income, and comparable transaction approaches. Each approach has its own advantages and drawbacks, and should be carefully considered based on the particular needs of the company being valued.
Footnotes
References
- Pinto J., Henry E. (2010)., Equity Asset Valuation, John Wiley & Sons, New Jersey, United States of America
- Pratt S., (2012)., The Lawyer's Business Valuation Handbook: Understanding Financial Statements, Appraisal Reports and Expert Testimony, American Bar Association, Chicago, United States of America
- Trugman G., (2012)., Understanding business valuation, American Institute of Certified Public Accountants, New York, United States of America
Author: Jakub Irauth
