Asset based valuation methods
Asset approach, also known as the cost approach, is one of the three major ways to value a business. Formally, this approach relies upon the economic principle of substitution:
The business value equals the cost of recreating an enterprise of equal economic utility.
The idea is that two businesses that generate the same economic benefits for their owners are worth the same.
Note that the asset approach implicitly states that under normal market conditions there is no such thing as an irreplaceable business. For every company, however unique, there is another one that is just as valuable.
If you are in the market to buy a business, you will likely have several candidates to investigate. If your preferred acquisition target does not work out, you will probably move on to the next business down the list. There is always the next best thing in the business market.
Major asset based valuation methods
Asset based valuation approach offers you a number of ways to determine the value of any business. The most common asset valuation methods used in professional business appraisals are these:
The asset accumulation method bears a superficial resemblance to the familiar balance sheet. You create a compilation of the business assets and its liabilities. Next, you assign the values to each. The difference between the sum total value of all business assets and liabilities is business value.
Sounds simple? The devil is in the detail: each business asset and liability must be painstakingly identified. In addition, there should be a way to allocate value to each of these. Some of the line items you may need to work with never show up on the typical business balance sheet: internally developed intangible assets such as patents, trademarks and trade secrets as well as contingent liabilities which may include environmental compliance costs and pending legal judgments.
The excess earnings method is actually a hybrid technique borrowing from the asset and income approaches. In addition to looking at the tangible assets and a set of business liabilities, the excess earnings method also helps you determine the value of business goodwill directly. To do so, the method uses the business earnings as input showing its connection to the income approach.
This unique strength makes the excess earnings method the top choice when valuing established companies with considerable goodwill.
Examples include professional services establishments such as law and accounting firms, medical practices and engineering / architecture companies. The method is also very useful when valuing manufacturing businesses, and successful technology companies, among others.
More on asset business valuation methods
Excess earnings method, known widely as the Treasury method, is preferred in professional business appraisals whenever the value of business goodwill needs to be established. This is the case for successful services companies, professional practices as well as manufacturing and technology firms. The method is widely used in valuations for divorce.
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