Recasting the Balance Sheet

The company value depends upon its asset base and the ability of the business assets to generate revenues and profits for the owners. The purpose of recasting the balance sheet is to ensure that the value of assets and liabilities accurately represents the business earning power. There are a number of balance sheet items that may require adjustment.

Typical asset adjustments for business valuation

Adjust the company assets from their cost-basis value to the current fair market value. A common technique is to determine the depreciated replacement cost of an asset. This is the cost required to replace the existing asset with a new equivalent, minus the adjustment for the time the asset has been in service.

Adjust the business liquid assets such as cash and short-term investments, to the level required to operate the business. Eliminate excess cash from the balance sheet. Account for the additional cash needed if it is below the required levels.

Adjust Accounts Receivable for uncollectible amounts. Review the accounts receivable aging report for proper assessment of the bad debt allowance.

Verify the inventory. Adjust to the current market cost, remove obsolete items, e.g. those that have not sold within the 12 previous months. The inventory should be valued on the FIFO basis since it tends to represent the current inventory value more accurately than the LIFO method.

Adjust any operating real estate to the fair market value. Current real property appraisal is recommended.

Business liabilities adjustments

Some of the business liabilities may also require adjustment from the book value:

Adjust below-market interest debt to current market rates. Assumable payments under such favorable debt financing terms should be discounted at the current market interest rate, which effectively reduces the present value of the liability.

Adjust deferred taxes for timing and amount of income tax payments.

Off-balance sheet item adjustments

Adjust the balance sheet for any off-balance sheet items, such as intangible assets and contingent liabilities. Examples of off-balance sheet assets include intellectual property such as internally developed products. Examples of off-balance sheet liabilities are an impending law suit settlement or regulatory agency compliance costs.