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Valuation

Asset-Based Valuation
A valuation method based on the value of a company’s assets or the
fair market value of its total assets after deducting liabilities

Written by CFI Team

Updated October 4, 2022

What is Asset-Based Valuation?

Asset-based valuation is a form of valuation in business that focuses on
the value of a company’s assets or the fair market value of its total assets
after deducting liabilities. Assets are evaluated, and the fair market value
is obtained.

For example, landowners may collaborate with appraisers to work out a

property’s market worth. Over time, property values increase, and a
proprietor may realize a piece of property is worth more today than it
was �ve years ago. The new value is quoted and is used in the asset-
based approach. On the other hand, liabilities often occur at true market
value. Usually, no further calculations are done. Asset valuation
determines the cost of recreating a similar business.

Breaking Down the Asset-based Valuation Approach

Cost includes actual machinery and equipment, as well as furniture.

However, it’s important to note that cost comprises lost income,
especially in cases where a business is listed. Items wear out, and they
need to be replaced eventually.

Additionally, the valuation process should consider economic and

functional obsolescence. Some companies own intangible assets like
technology that are outdated. For example, a business that still makes
use of vacuum tubes while rivals are enjoying nanotech is an indication
of an organization living in the past.

The asset-based valuation method is sound because there’s plenty of

�exibility regarding the interpretation when it comes to making a
decision on the assets and liabilities to consider in the valuation.

Asset-based Valuation Methods

1. Asset Accumulation Valuation

The asset accumulation method bears a striking super�cial similarity to

the widely known balance sheet. In the asset accumulation method, all
the assets and liabilities of a business are compiled, and a value is
assigned to each one. The value of an entity is the di�erence between
the value of its assets and liabilities.

As simple as it sounds, as always, the burden lies in the details. Each

asset and liability must be identi�ed carefully. In addition, the asset
accumulation method requires an e�ective way of assigning values to
assets and liabilities.

A few of the items typically used during valuation don’t always appear on
a standard balance sheet. They include internally generated intangible
assets like trademarks, patents, as well as trade secrets.  The list also
contains provisional liabilities, which may comprise compliance costs or
unresolved legal cases.

2. Excess Earnings Valuation

On the other hand, the excess earnings approach is a combination of the
income and assets valuation methods. Other than evaluating a
company’s tangible assets and liabilities, the method can also be used to
work out a business’s goodwill.

To determine goodwill, the earnings of a business are treated like input,

and then a connection is drawn to the income method. As a result, the
excess earnings method is highly preferred when valuing strong
businesses with substantial goodwill.

Typical examples include businesses that o�er professional services like

accounting and law �rms, engineering and medical practices, as well as
architectural �rms. The excess earnings method is also useful during the
valuation of manufacturing enterprises and well-established technology
companies.

Business Value vs. Selling Price

The selling price of a business and its value are not the same. The reason
businesses conduct asset-based valuation is to �nd out what an entity
would go for, theoretically speaking. However, practically speaking, the
value of an entity varies, based on the person doing the valuation.

So, an overexcited buyer looking to replace losses can choose to pay a

substantial sum just to acquire a business. Financial buyers tend to pay
quite low when acquiring a business.

There is also market exposure, which plays a signi�cant part as well.

Pitching the business to potential buyers is only half the task when
looking to achieve the best price.

Pros and Cons of Asset-based valuation

Most companies use the appropriate asset valuation method in cases

where they are experiencing issues relating to liquidation. Companies in
the investment niche – like �nancial or real estate investment, where
assets are calculated based on income or market approach – can also
use asset-based valuation.

That said, asset-based valuation is not without its drawbacks. Unlike

other methods, such as the income approach, the asset-based method
disregards a company’s prospective earnings. Putting concerns aside,
an entity’s business value can be much higher compared to when its
existing assets are disposed of item by item.

Since internally generated products don’t appear on the balance sheet,

the process of measuring intangible resources can be quite
complicated.

Valuing a company requires much more than just science. Asset

valuation requires profound knowledge, as well as experience, accuracy,
and attention to detail. Many businesses �nd the process quite
complicated, which discourages them from undertaking individual
business valuation.

Sometimes, the asset-based method becomes complex because few

businesses lack the required level of objectivity and accuracy necessary
to estimate their actual worth.

Conclusion

While there are several methods that can be used to value a business,
asset-based valuation is often preferred because of its applicability in
instances where a business is su�ering from challenges relating to
liquidity.

The asset-based method is highly favorable for core niches like the real
estate sector. However, it comes with its own disadvantages, such as the
fact that it’s quite complex, especially for those with little experience.

Related Readings

Thank you for reading CFI’s guide to Asset-Based Valuation. To keep

learning and advancing your career, the following resources will be
helpful:

Market Valuation Approach

Projecting Balance Sheet Items

Types of Assets

Valuation Methods