As much as we would like to just balance our revenue and expenses, there are a lot of reasons for businesses to know their valuation. To understand your business valuation, you need to determine the value of all of your assets — things like the fair market value of company stocks, fixed assets like buildings or equipment, and intangible assets like brand recognition or customer lists.
Once the net asset value of all of these things has been determined, a company can know its net worth by subtracting all of its liabilities from the present value of all of its assets.
Knowing your business valuation can help you make important decisions about:
- Buying and selling company shares
- Knowing the right purchase price for a company you hope to acquire
- Applying for loans and purchasing asset insurance
- Tax calculations on assets like property
Different Asset Valuation Methods
There are two main axes on which to think about asset based business valuation. The first is the asset valuation methodology, and the second is the type of asset you are trying to value.
There are many different methodologies, but the most common are the cost approach, the market approach, and the income approach. The cost approach considers how much investment was required to build the asset in question — or how much it would cost to replace it. The market approach uses the present fair market value of the asset. Finally, a methodology based on income forecasts the asset’s ability to bring cash into your business.
Each of these methodologies (and more) can be applied to many different types of assets. But some methodologies are more appropriate for certain types of assets than they are for others. When it comes to business valuation, there are three main types of assets: fixed assets, intangible assets, and stocks.
Below is a set of explanations of many different types of assets and how to apply various business valuation methods to them.
Fixed Asset Valuation Method
Fixed assets are tangible assets, and that means their quality can diminish over time. The roof of a factory building might begin to sag or a company car might develop transmission issues. With this type of wear and tear comes a decrease in their market value.
It is important for companies to account for the depreciation of their assets. Fixed asset valuation is a method of accurately reflecting those assets on the balance sheet. There are multiple different types of fixed asset valuation methods:
The cost method is the simplest form of asset-based valuation. Using the cost method of asset valuation, assets are valued with their purchase cost at their base. The valuer does not need to do any of the calculations to arrive at this value, and the current value of the asset is its value at the purchase price.
Market Value Method
Valuation using the market value method uses the market price — or its projected price — of the asset if it were to be available on the open market.
This is a method by which an asset is valued with consideration to its ability to generate a cash flow.
Intangible Assets Valuation
Some assets are not concrete objects like buildings or equipment, and that makes them more difficult to value. Examples of intangible assets include patents, client relationships, and brand recognition.
While it is hard to come up with an exact figure for these types of assets, there is no question that they have legitimate business value, and therefore, they are an important factor in determining one’s business valuation. Valuation of intangible assets can be determined by using a market approach, an income approach, or a cost approach.
Market Value Method
Using the market approach, you can value your intangible assets based on what other companies have paid for a similar asset. For example, if a company is not sure how to value their customer lists, but they know another company just bought a list of a similar size for a certain amount of money, they can use that figure as evidence of its market value.
The income approach values an asset based on the cash flow it is likely to bring into the business over time. Essentially, this method assumes that the asset’s present value is the value of its future income.
Finally, the cost approach to intangible asset valuation is when companies use the cost of rebuilding or replacing the asset under consideration. For example, if the asset is your brand recognition, you would have to tally how much it would cost to recreate that level of recognition in the market — including everything from graphic design to ad placements to favorable press hits.
Stock Valuation Method
Stocks are a type of asset that is not appraised like either fixed assets or intangible assets. Unlike a company car, you are not able to just kick the tires and inspect the belts under the hood. And unlike your brand equity, you can not expect people to recognize its value just because they are familiar with your logo.
Yet, there are a few ways to determine the value of your company stock that is similar to other asset-based valuation methods.
Discounted Dividend Model
This approach discounts the future dividends of a stock to its present value in order to calculate the stock price.
Discounted Cash Flow Model
Similar to the income method, the discounted cash flow model projects the stock’s future cash flow (projections usually go out around five years) and then discounts that projection using the weighted average cost of capital (WACC). In this way, a company can use the present value of projected future cash flows to determine the stock price.
This is the most straightforward of the stock valuation methods — although it does call for some equations. The easy part comes from the fact that you can simply refer to what peer companies have done. By referencing the valuation ratios of several of your peers (most commonly the price-to-earnings ratio, the price-to-book ratio, or the price-to-cash-flow ratio), you will be able to determine the value of your own stock.
Adjusted Net Asset Valuation Method
This is an asset-based business valuation method that bases a business’s value on the difference between the fair market value of its assets and its liabilities. Asset value is considered not for its value on the balance sheet but as a commodity on the market. It works well under the following conditions:
- The company is capital-intensive or is a holding company
- Losses are continually generated
- When cash flow valuation methods are lower than the valuation based on net asset value
Adjusted net asset valuation is helpful because it provides a “floor value” against which a company can compare its income-based or market-based value.
The Role of the Auditor
As you go through the process of valuing your assets, it is important to bring an auditor along for the ride. The auditor is responsible for ensuring that all assets have been appropriately valued, which helps a company’s price be aligned with its true and fair value on the financial statement.
There are several challenges facing auditors during this process that companies should consider:
- The nature of the asset: Different types of assets call for different valuation methods, so it is important to categorize them appropriately. But some assets are easier to classify than others.
- How the assets are used: Sometimes an asset’s function within the company changes, and that can be difficult to track when it comes time to appraise it.
- The life of the asset: Many methods call for a certain degree of speculation into the future, which always brings an element of the unknown into the process.
- Future contingencies: Sometimes the value of an asset changes after the audit is complete — a building might burn to the ground, for example. When this happens, it can create a lot of doubling back to put the balance sheet back in order.
- Inadequate facts: Business valuation can be enormously complicated, and there is some inherent risk that something might get overlooked, or user error might come into play. This can lead to an inaccurate valuation.
For all of these reasons, companies should be sure to have everything well in order before they begin the asset valuation process.
There are many different methods of valuation for companies to consider, and every business will have to develop an approach that is specific to its own collection of assets. While this can be a major challenge, businesses do not have to go through the process alone.
Succession Resource Group has decades of experience providing the most comprehensive valuation services in the financial industry. This year alone, our award-winning team of professionals has valued hundreds of businesses. If you are buying, selling, or planning the sale of your business, we can help you go through the process in the most efficient and cost-effective manner possible. Please contact us today for a consultation and let us help guide you through the valuation process.