There are three approaches that business valuations use, and this video covers the asset approach. This video focuses on when to use the asset approach and how to use it.
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Certified Business Valuators utilize three approaches when valuing your business. Here we do an in-depth review of the Asset Approach which is provides a way to determine a value for your business based on the value of the assets, net of the liabilities.
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Hi, I’m Sheila Darby, a managing director here at BizWorth. Thank you for joining me for this video on how to value a business. This is a video covering the asset approach and this follows the introductory video that introduced three approaches to you.
The three generally accepted valuation approaches as a reminder, are the asset approach, the income approach and the market approach. This video is going to focus on the asset approach. What is the asset approach? The asset approach provides a way to determine a value for your business based on the value of the assets, net of the liabilities. There are several instances where you may really want to use an asset approach, but with that being said, a valuation, a certified evaluation professional is going to consider the asset approach for every valuation engagement. And depending on the facts of the valuation engagement, we may choose to use the asset approach or not to use the asset approach, but there are sometimes when the asset approach can be very insightful. Those are for holding companies, investment companies, businesses that generate losses, companies that may be considering liquidating and high valued real estate companies. Those are just some of several good examples of when the asset approach may be particularly insightful.
To use the asset approach, there are methods that you would employ to value a company based on the asset approach. There’s two very common methods. The first is the book value method and the second is the adjusted net assets method.
The book value method is a very well-known and popular method for valuing a business. This is based on the assets and the liabilities that are reported according to various accounting conventions. This method may or may not reflect the current value of a business. Again, these are the assets and liabilities reported at historic value based on accounting conventions.
For this example, I want to first introduce the company we will be looking at. The owner was a gentleman that was probably in his late sixties, early seventies and he reached out to BizWorth. I had a meeting with him and learned that had a very successful first business, sold it, got bored and wanted to start a second business. He created a medical records business which had revenues fluctuating between $350,000 to 500,000 per year over the 20-year life span. It wasn’t a huge business, but it was a very good business that consistently generated profit for the owner. In talking with him, he spoke about the revenues and how predictable they were and that he was ready to finally retire. He wanted to get rid of the business and turn a profit. He was thinking maybe somewhere in line of “hopefully I can sell my business between $150,000 and $350,000, maybe 500,000,” but he didn’t quite know what the value ought to be.
We walk business owners through the three general approaches and how we’ll look at the business, and one of the approaches that we discuss with business owners is the asset approach. We had a quick conversation around the assets of his business, and he let it be known that his medical records business that was serving one small regional geographic area was inside of a very large building. The tax value on this building was already something greater than the historic value, the book value of, of his land and of his building.
This is a rough idea of what his balance sheet looked like (we’ve changed lots of numbers here), but I thought it’d be fun to try to see a somewhat real example. This company had cash, accounts receivable and inventory, but you can see that this company also had land, buildings and a large amount of accumulated depreciation on the books. In total, the total fixed assets of this business were almost $300,000. There was also a small amount of current liabilities and you can see where the total equity of this business was. In valuing his business, based on the historic book value method, the historic assets were approximately $447,000, historic liabilities were approximately $385,000 and the value of this business came out to be approximately $63,000 (based on historic book value. Knowing that this probably was not a good representation of his business, the next step for a valuation professional is to look at the adjusted net assets method.
The adjusted net assets method is the book value of the assets when they are adjusted to fair market value. This could be measured as a replacement cost or liquidation value. If there is land and buildings, you could have a real estate appraisal that would inform what the fair market value is. This fair market value of the assets are then reduced by the fair market value of all the recorded and unrecorded liabilities. For this company, what does that mean? There was an adjustment made for the land and the depreciable buildings. We just showed this complete adjustment in one entry on the balance sheet for simplicity, but this should be broken up according to the land and the buildings. When you look at the value adjusted for this, you’ll see that the adjusted value is $884,000 as compared to the $63,000. For this particular company that was sitting on very valuable land in inside of a valuable building, this was probably going to be the best valuation approach for this business owner and that cannot be said for all businesses. This business was using maybe 1/10th of the building that they were located in and for being on a very valuable piece of property and inside of a building, the asset approach was likely going to be the best approach. It was not going to be the book value that was going to place an indication of value of $63,000, but it was going to be this adjusted net assets method that was going to prove to be the most insightful and provide the most current value for this particular business.
So, you can see if someone’s just relying on the book value how much money would have been left on the table. In most instances, the income approach and the market approach will likely yield a higher value than the asset approach. It’s certainly not for all businesses such as holding companies, high valued real estate companies, companies close to liquidation value, or companies that are generating losses. However, there are those cases that there are profitable businesses that the asset approach will still yield the most insightful current value for the particular business.
With that example, I hope the asset approach makes more sense. I hope the overview of the book value method and the adjusted net assets method is helpful. Please reach out if you have any questions. If you go to our web site, www.BizWorth.com, you can schedule an appointment to meet with me or one of our advisors to talk about your business valuation. Even if you’re not sure it’s the right time for a business valuation, hop on a free consultation and let’s talk through that. We’re always happy to help business owners so feel free to reach out. If you like our content and would like to see more, visit our blog or follow us on Facebook, LinkedIn, and YouTube. Thanks so much.
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