The Asset Approach – What is an Asset Based Valuation?

The Asset-Based Approach in Brief

Using an asset-based approach to business valuation means basing the valuation on the net asset value of the business. This is done by subtracting all liabilities from total assets. To represent the fair market value of the business, you must use the market value of the assets and liabilities, not just the book value.

Making an Asset Approach Valuation – Step by Step

A company’s net worth is equal to its total assets minus its total liabilities. On the balance sheet this is called equity.

If you just looked at the value of the equity on the balance sheet, the valuation would be done in less than a minute. The problem with this approach is that the market value of assets rarely equals their book value. On the balance sheet, the value of assets is regularly reduced by depreciation. Their true market value is often higher, but it can also be lower. This problem does not affect liabilities to the same extent, but they must be considered as well.

Example:

• A company purchases 15 big tractor trailers for $150,000 each and a total of $2,250,000.
• The accountant uses IRS MACRS depreciation and a 5-year depreciation schedule. This means that after 5 years, the book value of the trailers is zero.
• However, it is not uncommon for tractor trailers to have a 20%-30% rest value after 5 years.
• If the appraiser had used the book value of the trailers, he would have undervalued it by approximately $1,125,000.

Therefore, when performing an asset based valuation, it is important to first normalize the balance sheet to reflect current market prices.

Pros and Cons with an Asset Based Approach Valuation

The beauty of the asset approach is its simplicity. Assets and liabilities are usually easy to identify. This approach provides a quick and robust way to calculate the value of a business without having to use complex formulas or heavy assumptions.

However, the amount of work that goes into a reliable business valuation using the asset approach is easily underestimated. Simply using book value will lead to incorrect results. Most of the work goes into finding the true market value and identifying off-balance sheet assets and liabilities.

Income And Profits are Ignored

Earnings or growth are not reflected in an asset based valuation. Often it does not even include intangible assets, but that is up to the appraiser to decide. However, it is a tedious task to determine the value of intangible assets.

Sometimes the asset based approach can be used as the only valuation method. For example, if you need to quickly determine an approximate floor price for your business, this approach will help. It is also useful when valuing a business to be liquidated.

Often Used with Other Approaches

However, the full potential of the asset approach is realized when used in conjunction with other valuation approaches. At Nielsen Valuation Group we often use it on top of an appraisal done with the income approach, to provide a balanced and fully IRS compliant valuation.