What it means
The method starts from the balance sheet but does not trust it. Accounting values reflect historic cost less depreciation, so the valuer revalues property to current market prices, marks inventory down to what it would really fetch, tests receivables for collectability, and adds liabilities the accounts have not yet recognised such as warranty exposure or dilapidation costs.
The result is often called adjusted net asset value. It is the right approach in specific situations.
Holding companies, property businesses, investment vehicles and asset-heavy firms with weak or volatile profits are all natural candidates, because the assets themselves are where the value lives. It is also the standard method when a business is being wound up, since the question is simply what the assets will realise.
The approach comes in two flavours that give very different answers. A going concern basis values assets as they stand in a working business, while a liquidation basis values them at what they would fetch in a forced or orderly sale, which is usually far less.
Specialist machinery may be worth $500,000 in place and $80,000 at auction, so stating the basis is essential. Its main weakness is that it ignores earning power.
A consultancy with $200,000 of laptops and desks might generate $2,000,000 of annual profit, and an asset-based valuation would badly understate it because brand, client relationships and staff capability are not on the balance sheet. For most trading businesses the asset value acts as a floor rather than as the answer.
In practice valuers often run more than one approach and compare. If the asset-based figure comes out above the income-based figure, that is a strong hint the business is not earning an adequate return on what it owns, and an owner might realise more by selling assets than by continuing to trade.
That comparison is frequently the most useful output of the whole exercise.
In practice
Real-world examples.
Example
A family property investment company is valued for probate. Because its only real activity is collecting rent from six buildings, the valuer revalues each property, deducts the mortgages and reports the net figure. No profit multiple is used at all.
Example
A loss-making textile manufacturer is being sold. The buyer values it on a liquidation basis, pricing the looms at auction values and the freehold site at development land value. The offer comes in below book equity because the specialist machinery is worth far less second-hand.
Example
A shipping partnership uses the asset-based approach at each year end because vessel values are quoted in an active market. Charter income varies wildly, so the fleet valuation is the more reliable measure. Partners' capital accounts are restated annually on that basis.
Formula
Calculation
Adjusted Net Asset Value = Adjusted Total Assets - Adjusted Total Liabilities
Ferngate Engineering shows total assets of $6,000,000, total liabilities of $2,500,000 and book equity of $3,500,000. A valuer makes four adjustments.
Property is revalued upwards by $900,000 to current market value.
Obsolete inventory is written down by $150,000.
The allowance against doubtful receivables is increased by $50,000.
An unrecorded warranty obligation of $100,000 is added to liabilities.
Adjusted total assets = $6,000,000 + $900,000 - $150,000 - $50,000 = $6,700,000.
Adjusted total liabilities = $2,500,000 + $100,000 = $2,600,000.
Adjusted net asset value = $6,700,000 - $2,600,000 = $4,100,000.
The valuation sits $600,000 above book equity of $3,500,000, driven almost entirely by the property revaluation offset by the three downward adjustments of $150,000, $50,000 and $100,000.Case study
Seen in the real world.
Ashgrove Timber is an illustrative, fictional sawmill business used to show why the approach is chosen. Its accounts showed book equity of $2,200,000 and it had been reporting only modest profits for several years, so an earnings-based valuation produced a disappointing number for the retiring owner.
The valuer took an asset-based view instead. The mill sat on land bought forty years earlier and carried at historic cost, and a current market valuation added $1,400,000. Against that, the older cutting line was heavily specialised and worth much less than book value in any realistic sale, so $300,000 was written off.
The adjusted net asset value came to $2,200,000 + $1,400,000 - $300,000 = $3,300,000, comfortably above what the profits alone would support. In this illustrative case the finding changed the outcome: the family concluded the site was worth more than the trade running on it, and sold the land to a housing developer while transferring the sawmill operation to a smaller leased unit.
Watch out
Common mistakes.
- Using unadjusted book values straight from the accounts and calling it an asset-based valuation, when the whole point is restating each item to current worth.
- Failing to state whether the valuation is on a going concern or liquidation basis, which can change the answer by more than half.
- Applying the approach to a profitable service or brand-led business, where the most valuable resources never appear on the balance sheet.
Questions
People also ask.
When is the asset-based approach most appropriate?
For property companies, holding companies, investment vehicles, asset-heavy firms with weak profits, and any business being wound up.
Does it include intangible assets?
It can include separately identifiable intangibles such as licences, patents or brands where a defensible value exists, but internally generated goodwill is normally excluded.
Why might it produce a higher figure than an earnings valuation?
Because the business is not earning a proper return on the assets it holds, which is itself a useful signal that the assets could be redeployed or sold.
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