What it means
Business valuation has three broad families: income approaches based on future profits or cash flow, market approaches based on what similar businesses sold for, and asset approaches. The adjusted net asset method is the main asset approach, and it treats a company as a collection of things that could be sold rather than as a stream of earnings.
The work is done line by line. Land and buildings are revalued by a surveyor, equipment by an appraiser, inventory to net realisable value, receivables net of realistic bad debts, and investments to market price.
Liabilities receive the same treatment, and this is where the surprises usually appear. Litigation, warranty claims, dilapidations on leased premises, unfunded pension obligations, site remediation and deferred tax on revaluation gains all reduce the final answer.
The result depends heavily on the assumption sitting behind it. A going concern valuation uses orderly market values, while a liquidation valuation uses forced sale values, which for specialised equipment with few buyers can be 30% to 60% lower.
The method's blind spot is intangible value. It systematically undervalues businesses whose worth lies in brand, staff, software or customer relationships, which is why an income approach almost always produces a higher figure for a profitable service company.
Valuers therefore run it as a cross-check even when using an earnings method. If a company's earnings-based value comes out below its adjusted net asset value, a rational owner would sell the assets rather than keep trading.
In practice
Real-world examples.
Example
A holding company whose only activity is owning three commercial units and a share portfolio is valued for a divorce settlement. Earnings are almost irrelevant, so the valuer restates the properties and the portfolio at market, then deducts the mortgages and the deferred tax on the gains.
Example
An insolvency practitioner assesses whether a struggling printer is worth more sold whole or broken up. Forced sale values on the presses come in 45% below their orderly market value, which makes selling the business as a going concern the better outcome for creditors.
Example
A loss-making steel fabricator receives a $2,000,000 offer from a competitor. Its adjusted net asset value, driven by a freehold yard worth $3,400,000, comes to $3,100,000, so the directors reject the offer and plan an orderly wind-down instead.
Formula
Calculation
Adjusted net asset value = fair market value of assets - fair market value of liabilities
A regional plant hire business reports total assets of $12,000,000 and total liabilities of $7,000,000, giving book equity of $5,000,000. The valuer makes five adjustments: land and buildings carried at $6,000,000 are worth $10,500,000, adding $4,500,000; specialised plant is written down by $600,000; inventory falls $200,000 to net realisable value; a further $100,000 of receivables is judged uncollectable; and an unrecorded site remediation obligation of $500,000 is brought in.
Adjusted assets = $12,000,000 + $4,500,000 - $600,000 - $200,000 - $100,000 = $15,600,000. Deferred tax on the property gain at 25% is $4,500,000 x 0.25 = $1,125,000, so adjusted liabilities = $7,000,000 + $500,000 + $1,125,000 = $8,625,000.
Adjusted net asset value = $15,600,000 - $8,625,000 = $6,975,000, against reported book equity of $5,000,000. The extra $1,975,000 is what the accounts were hiding once the yard was valued at today's prices and the clean-up bill was recognised.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Ordway Cold Storage, an invented family-owned chilled warehousing business, reported assets of $18,000,000 and liabilities of $11,000,000, giving book equity of $7,000,000. Profits were modest at $700,000 a year, and an earnings approach at six times profit suggested the company was worth only 6 x $700,000 = $4,200,000.
The asset approach told a different story. The two warehouses, carried at $9,000,000, sat on land worth $16,000,000 to a distribution developer, adding $7,000,000. Ageing refrigeration plant was written down by $1,200,000 and receivables by $300,000, giving adjusted assets of $23,500,000. Deferred tax of 25% on the property gain added $1,750,000 to liabilities, and a survey uncovered $900,000 of asbestos removal, so adjusted liabilities came to $13,650,000 and the adjusted net asset value to $9,850,000.
Faced with a business worth more than twice its earnings value, the fictional family sold the freeholds to a property investor and leased the warehouses back on a long lease. The illustrative point is that the adjusted net asset method does not just produce a number; it can reveal that the assets and the trading business are worth more apart than together.
Watch out
Common mistakes.
- Using the method for a profitable service business, where it ignores the brand, staff and contracts that make up most of the value.
- Revaluing assets upward without deducting the tax that would be payable if those assets were actually sold.
- Confusing orderly market value with forced sale value, which can overstate a liquidation outcome by half on specialised plant.
Questions
People also ask.
When is this method the right choice?
For property companies, investment holding companies, asset-heavy businesses earning poor returns, and any company being valued for liquidation or a break-up.
Does it include goodwill?
Purchased goodwill on the balance sheet is usually removed, and internally generated goodwill is not added, which is exactly why the method gives a conservative answer.
How does it differ from adjusted book value?
In practice the two describe the same arithmetic, with adjusted net asset method being the term valuers use for the formal valuation approach and adjusted book value the resulting figure.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%