This approach may apply when a business
has marginal earning potential but notable
retained earnings. Retained earnings
represent value received in the purchase of
the business and may be included as part of
overall adjusted book value. The book value
or fair value (or combination thereof), of
asset components is summed to arrive at a
final estimate. Fair value (the amount at
which an asset could be bought or sold
between willing parties), is referenced
given its frequent use by accountants when
assets are fairly valued for purposes of
financial reporting. Without delving too far
into semantics, fair value in the accounting
profession and market value in real estate
brokerage can be viewed as roughly
equivalent, while acknowledging subtle
differences in the formal definitions.
Method of Calculation:
Tangible net worth (retained earnings), is
obtained from the latest statement of assets
and liabilities. This amount is used as a
component in arriving at a final value.
Additional asset values would then be
analyzed either at book value or an adjusted
value that more adequately reflects fair or
market value.
Inventory at cost or fair value (as
determined by the parties).
Equipment/fixtures at cost or fair
value (as determined by the parties).
Leasehold improvements at cost or
fair value (as determined by the
parties).
The total value
includes retained earnings plus adjusted
book values. In the example, fair
value of equipment was included. The
adjusted book value need not equal fair
value and in fact a smaller value might have
been negotiated, e.g., value under forced
sale conditions.
Asset Valuation
Often businesses are valued simply based
on saleable assets without regard to
financial performance. Inventory, equipment,
fixtures, and supplies are analyzed
separately with no consideration given to
the operating business as it is normally
excluded from the sale. Obviously, the
seller will want the highest figure and the
buyer the lowest. The amount paid for assets
largely depends on the negotiating
strategies of the parties. As with adjusted
book value, bargaining typically ranges
between book value and fair value for
assets. Asset valuation is a popular
technique as the individual is not acquiring
the business, only its assets. Accordingly,
any potential liabilities are not being
assumed.
A wide range of calculation methods are
found in the marketplace given unique
businesses and negotiating strategies. To
complicate matters, clear-cut lines between
asset valuation, adjusted book value, and
other valuation techniques can become
blurred. For example, goodwill can arise in
negotiations despite financial performance
of the business. This non-tangible asset may
nevertheless have value, e.g., the
longstanding reputation of the business, the
capabilities of management and staff, and
product reputation. Goodwill is typically
quantified by analyzing above average return
on investment (attributable to goodwill),
however, this is not to say that goodwill
cannot exist even with marginal earnings.
Again, buyer and seller perspectives
frequently drive negotiations. In such
instances, goodwill is regarded like any
other asset such as equipment, inventory, or
other tangible items.
Asset valuation can also expand to other
values, for example, leasehold interests.
Assume a business leases 2,000 square feet
with a particularly favorable rate, e.g.,
$7.00 per square foot for four years and
current market rent is $15.00. If the
current rate remains at $15.00, the
leasehold benefit is:
2,000 square feet x $8.00 x 4
years = $64,000
Using the discounted cash flow and an
appropriate rate, the present value of this
economic benefit can be established and
included in the value of the business.
Adjusted book value or asset valuation
can be useful as a secondary valuation
technique to confirm or dispute
capitalization or discounted cash flow
approaches. Two alternate business valuation
methods, the liquidation method and the
formula method, are not detailed as they
involve extensive judgmental factors by the
valuator.
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