The asset approach to business valuation

The asset approach to business valuation provides for the sum of the parts of a business. Those assets may include tangible and intangible assets. It is sometimes referred to as the "cost approach".

Limits of the asset approach to business valuation


Without other methods, this approach can only value non-operating companies. The asset methods can corroborate or supplement other approaches in operating companies.

Any use of a stand-alone asset approach in an "asset intensive" business is nonsense. Beware of this smokescreen in an underperforming business.

A company acquiring assets does not gain value from them. It must first sweat those assets into profits. We have seen the downside of this nonsense, and it is not pretty.

Case study in asset-based business valuation

A plumbing distributor had grown his business over decades within the building industry. He showed me a warehouse packed to the rafters with all manner of plumbing goods. So many fittings; from taps and mixers, to fountains and showers, to baths and toilets and geysers.
“Five million Rands, at cost,” he told me. “I bought a lot of it in bulk. He pointed to a section of about a quarter of the warehouse, “I bought it at the auction when (a competitor) went under. That was a really good deal.”
There was a thick layer of dust on some of the items. And I remembered the liquidation of that other business.
“The inventory we sell most is in this corner. The rest of the goods move slower.”
“But why do you buy this if you know that it will move only over a very long time?”
“It all adds to the value of the company.”

His helpful accountant supported the notion. His bankers supported the notion with an overdraft facility.
But the inventory was not moving, and the company struggled to pay its overhead.
If he spoke the same good fight to his bankers and accountant, I could see why they agreed with him.

The asset-based approach to business valuation is a key method in non-operating companies.

Use an asset valuation for

  •   real-estate owning companies
  •   investment holding companies
  •   group companies
  •   companies that are not going concerns
  •   failing enterprises

The asset based approach in operating companies

Use the asset approach for operational companies to compare the other results.

The asset-based approach is not additional to one of the other methods. It is to complement the results of another.

adding the income based result to the asset value is a mistake that rookie small business buyers fall for.

A result using the income approach to business valuation is of the complete business. It includes ALL those assets required to generate its income.

At the time of a sale, goodwill is the (positive) difference between the selling price and the asset value.
What if the business is not sold? The difference between an income based valuation and the value of assets is goodwill. As an asset, goodwill can be handy for tests of factual solvency.

Types of asset-based approaches to business valuation

Net asset value

Adjusted book value

Net asset value

Net asset value approach to business valuation is often referred to as “book value”.

You don’t need a business valuation to see what this is. Look in your financial statements, at the balance sheet. it is under “equity” or “capital and reserves”, and may be the sum of various items:

  • Share capital / members’ interest
  • Retained income
  • Distributable profits
  • Accumulated profit

In theory, if the company were to

  • collect from all it debtors as reflected in long-term and current assets,
  • collect from all it debtors as reflected in long-term and current assets,
  • use that cash, together with the cash it has in the bank
  • to settle all its own current and long-term debt, then
  • the remainder is the net asset value (NAV). 

The NAV is distributable amongst the shareholders. Of course the balance sheet never reflects:

  • the cost and viability of early collection,
  • early settlement penalties,
  • retrenchment costs,
  • leave pay liabilities, or
  • real market value of the assets.

Using net asset value as an approach to business valuation is quick, easy, and exceptionally cheap.

But you get that for which you pay!

Case study in asset-based approach to business valuation

In 2002 I was mandated to sell a business for its net asset value. I was on a commission agreement, and wanted to make more money. It took five months, but we sold it for 2,5 X its net asset value. I believe that the price achieved in that instance was a bit more than the business value. It was a great deal more than the net asset value.

Adjusted book value

Tangible book value
Economic book value
Marketable asset value
Fire-sale asset value
Tangible book value

The net asset value, less intangibles. Intangibles would include:

  • goodwill,
  • patents,
  • start-up capital expenses, and
  • some financing costs.
Economic book value

Economic book value adjusts assets to their market value. This includes:

  • intangibles such as goodwill and patents,
  • fixed properties,
  • stock in other companies.
  • fixed assets at their market value, and
  • Inventory at market value. This last part about inventory is important. Inventory in the balance sheet is at the cost of acquiring it, it being unsold at its profit. Economic book value allows for the valuation of inventory at its market value. Some will argue this means what customers would pay for it.
    It means the value the business would pay for it at the valuation date.
Marketable asset value

This is the sum of the prices the assets could be sold:

  • in a well controlled sale
  • in good time,
  • having settled all outstanding debts. It is particularly valid for property portfolio companies. It is also valid for investment companies which are non-operational.

In operational companies, use it only with at least one of the other approaches:

  • the income approach, and/or
  • the market approach - It requires the services of a sworn property valuer. Estate agents or business valuers who are not sworn property valuers may not charge to do them.
Fire-sale asset value

There is not much a business valuation practitioner can do here. It is the realm of the auctioneers. We have seen them place value on good assets at a fraction of any of the other methods.

The fire-sale asset value is the main topic of business rescue creditor meetings.

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