Asset Approach to Business Valuation
The asset approach to business valuation values the assets of the business minus the liabilities. The asset approach is one of the four primary business valuation approach, and it also happens to be the simplest business valuation method. The glossary published on Business Valuation Resources defines the asset approach as “a general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilities.” We will go over the various adjustments that might be made to the assets and liabilities in order to calculate the net assets, which is equivalent to the equity of the business (assets – liabilities = equity).
It is typically only used as a valuation “floor value,” or lowest value that a business buyer would value the company they are looking to purchase. Additionally, the asset approach to business valuation might be used due to a liquidation, either orderly or forced, as the business is not expected to be a going concern moving forward. In essence, the specific business will not be operating into the future, so the business buyer will need to understand the value of the net assets. The most popular approach to this would be to value the assets at fair market value, then subtract the liabilities at fair market value. This is referred to as the adjusted net assets method, which falls within the asset approach. By valuing both assets and liabilities at fair market value, the business buyer can have a strong understanding of the remaining equity value of the business.
How is it calculated: identify the fair market value of the assets (both on and off balance sheet) and then subtract the fair market value of the liabilities
When to use it: Best used for a business buyer that is only interested in the net assets of the business, a business seller looking to liquidate their business as quickly as possible, or in situations where there is little profitability and future profitability is questionable
Pros
- Not used as commonly as the other valuation methods
- Will likely yield the lowest valuation for a going concern company
Cons
- Needs accurate historical financials to be useful
- Not suitable for startup businesses or businesses where the near-term economic outlook is unstable or declining
- Does require reference amounts, either the asking price or another calculated amount, to base the profits and/or total investment amount off of
Illustrative Example Business Case for Calculating Business Valuation Using the Asset Approach Sam’s Coffee Shop
Here it helps to look at an illustrative example to demonstrate the asset approach to business valuation. The company we will look at is a coffee shop called Sam’s Coffee Shop. Unfortunately, the coffee shop has fallen on hard times. Sam, the business owner, is looking to sell the business as the company is no longer profitable and the future earnings potential of the business is very questionable. Given the circumstances, including the fact that the business is very unlikely to be profitable in the near future, the value of the business will be calculated using the asset approach method.
In this scenario, an interested business buyer named Bill finds a listing of the coffee shop business for sale. Bill sees that the business is unprofitable and appears to be on a downward trajectory, with little chance of the coffee shop returning to profitability for quite some time. Bill, therefore, decides to value the business according to the net assets valuation of the business. Bill decides to request the most recent balance sheet in order to calculate the value of the net assets.
Below are the steps that would need to be followed in order to calculate the value of the Sam’s Coffee Shop business:
Step 1
Listing of all assets and liabilities of the business
Step 2
Calculation of the fair market value of all of the assets and liabilities of the business
Step 3
Subtraction of the fair market value of the liabilities from the fair market value of the assets in order to arrive at the equity value, also referred to as net assets value, of the business. Remember, the equation for this is Assets – Liabilities = Equity
Calculating the Inputs
STEP 1
Sam, the business owner, provides Bill, the potential business buyer, with a list of the value of the assets and liabilities according to the official balance sheet as prepared by Sam’s accountant. The table can be found below:
| Assets | |
|---|---|
| Current Assets | Book Value |
| Cash | $100,000 |
| Accounts Receivable | $150,000 |
| Inventory | $40,000 |
| Other Currents Assets | $10,000 |
| Total Current Assets | $300,000 |
| Fixed Assets | |
| Furniture and Fixtures | $20,000 |
| Automobile | $25,000 |
| Equipment | $30,000 |
| Accumulated Depreciation | $25,000 |
| Total Fixed Assets | $50,000 |
| Intangible Assets | |
| Goodwill | |
| Total Assets | $350,000 |
| Liabilities | |
| Current Liabilities | |
| Accounts Payable | $250,000 |
| Long-Term Liabilities | |
| Equipment Loan | $20,000 |
| Total Liabilities | $270,000 |
STEP 2
Bill, the business buyer, enlists his accountant to help him figure out the fair market value, which is the price the assets would sell for on the open market and the amounts due to other parties on the outstanding liabilities. The updated table can be found below:| Assets | Book Value | Fair Market Value |
|---|---|---|
| Current Assets | ||
| Cash | $100,000 | $100,000 |
| Accounts Receivable | $150,000 | $120,000 |
| Inventory | $40,000 | $40,000 |
| Other Currents Assets | $10,000 | $10,000 |
| Total Current Assets | $300,000 | $270,000 |
| Fixed Assets | ||
| Furniture and Fixtures | $20,000 | $10,000 |
| Automobile | $25,000 | $10,000 |
| Equipment | $30,000 | $15,000 |
| Accumulated Depreciation | $25,000 | $ – |
| Total Fixed Assets | $50,000 | $35,000 |
| Intangible Assets | ||
| Goodwill | ||
| Total Assets | $350,000 | $305,000 |
| Liabilities | ||
| Current Liabilities | ||
| Accounts Payable | $250,000 | $240,000 |
| Long-Term Liabilities | ||
| Equipment Loan | $20,000 | $20,000 |
| Total Liabilities | $270,000 | $260,000 |
STEP 3
Bill and his accountant subtract the fair market value of the liabilities from the fair market value of the assets in order to arrive at the equity value, also referred to as net assets value, of the business. It appears that the adjusted net assets value of the coffee shop business is lower than the latest book value of the business.
| Assets | Book Value | Fair Market Value |
|---|---|---|
| Current Assets | ||
| Cash | $100,000 | $100,000 |
| Accounts Receivable | $150,000 | $120,000 |
| Inventory | $40,000 | $40,000 |
| Other Currents Assets | $10,000 | $10,000 |
| Total Current Assets | $300,000 | $270,000 |
| Fixed Assets | ||
| Furniture and Fixtures | $20,000 | $10,000 |
| Automobile | $25,000 | $10,000 |
| Equipment | $30,000 | $15,000 |
| Accumulated Depreciation | $25,000 | $ – |
| Total Fixed Assets | $50,000 | $35,000 |
| Intangible Assets | ||
| Goodwill | ||
| Total Assets | $350,000 | $305,000 |
| Liabilities | ||
| Current Liabilities | ||
| Accounts Payable | $250,000 | $240,000 |
| Long-Term Liabilities | ||
| Equipment Loan | $20,000 | $20,000 |
| Total Liabilities | $270,000 | $260,000 |
| Equity/Net Assets | $80,000 | $45,000 |
With the fair market net assets value of the coffee shop business in hand, Bill then works with business broker to negotiate a purchase of Sam’s Coffee Shop. He has the knowledge of what he could receive for the net assets on the open market, so his goal is to find a price below that value as he negotiates with Sam to purchase the business.
Summary
The asset valuation method for small businesses is best used for businesses that are not expected to continue operating post-acquisition. The goal is to calculate the net fair market asset value of the business for the business buyer. As it involves a thorough review of the balance sheet and calculation of the fair market value of the balance sheet, an accounting professional is typically recommended.
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