Understanding Asset-Based Valuation and its Different Types!

In the previous article we looked at some of the real-world examples on how to use Relative Valuation Multiples and if you haven’t read that already here’s the link: Understanding Relative Valuation Multiples Through Real-World Examples!  Now that we have understood how everything about Relative Valuation, we’ll now move on to the Asset Based Valuation Method, where we’ll understand what it is and its different types.

Asset Based Valuation and Its Different Types

Asset Based Valuation (ABV) is a fundamental approach used to estimate the value of a business by focusing on the total value of its assets minus its liabilities. This method offers an objective measure, especially useful in situations like mergers, acquisitions, or liquidations, making it a vital tool for financial analysts, business owners, and investors.

What Is Asset Based Valuation?

At its core, ABV determines the net asset value of a company:

Value of Total Assets - Total Liabilities = Net Asset Value

Analysts assess both tangible assets (like real estate, machinery, inventory) and intangible assets (such as patents, trademarks, and goodwill). Liabilities, both recorded and contingent are subtracted to arrive at the value.

Key Features

• Incorporates both tangible and intangible assets
• Can use book, market, or adjusted values
• Appropriate for businesses with substantial asset bases or during liquidation
• Flexibility in accounting for off-balance-sheet items

Main Types of Asset Based Valuation

1. Asset Accumulation Method

This straightforward method compiles a company’s assets and liabilities, assigns appropriate values to each, and calculates the difference:

• Every asset and liability is identified and assigned a fair value.
• Intangible assets such as trademarks and patents, along with contingent liabilities, are included if not on the balance sheet.

This method closely resembles a detailed balance sheet but is more comprehensive due to its inclusion of off-balance-sheet items. It is particularly useful when valuing companies where assets are central to value, such as manufacturing or real estate firms.

2. Adjusted Net Asset Method

Here, the book values of assets and liabilities on the balance sheet are adjusted to their fair market values based on current market conditions. This means reflecting depreciation, obsolescence, and market variations for a more accurate assessment. The method allows for modifications, such as including or excluding certain intangible assets, making it more adaptable for many scenarios.

3. Excess Earnings Method

This hybrid approach combines asset and income valuation. It is often used to estimate a company's intangible value or goodwill:

• The value of tangible assets is calculated first.
• Then, the company’s expected earnings are assessed.
• Any excess earnings (beyond a reasonable return on tangible assets) are attributed to intangible assets like goodwill.

This method is particularly favoured for businesses with significant intangible value, such as established service firms or tech companies.

4. Liquidation Value Approach

This type calculates the value a business could realize if all assets were sold and liabilities paid off often used when businesses are closing or being liquidated. It typically results in a lower value than going-concern methods.

Conclusion

Asset Based Valuation provides a rigorous, asset-focused method for valuing companies. By leveraging different types, such as Asset Accumulation, Adjusted Net Asset, Excess Earnings, and Liquidation Value one can tailor valuations to a business’s circumstances, balancing tangible and intangible contributions to enterprise worth.

What’s Next?

Now that you have a solid understanding of asset-based valuation and its various approaches, our next article will focus on when to choose this method and how to decide which type of asset-based approach is most appropriate. Until then stay tuned as we work on the next article.