What is Asset Valuation?
Asset valuation simply pertains to the process to determine the value of a specific property, including stocks, options, bonds, buildings, machinery, or land, that is conducted usually when a company or asset is to be sold, insured, or taken over. The assets may be categorized into tangible and intangible assets. Valuations can be done on either an asset or a liability, such as bonds issued by a company.
Asset Valuation – Valuing Tangible Assets
Tangible assets refer to a company’s assets that have a physical form, which have been purchased by an organization to produce its products or goods or to provide the services that it offers. Tangible assets can be categorized as either fixed asset, such as structures, land, and machinery, or as a current asset, such as cash.
Other examples of assets are company vehicles, IT equipment, investments, payments, and on-hand stocks.
To compute the net tangible assets of a company:
- The company needs to look at its balance sheet and identify tangible and intangible assets.
- From the total assets, deduct the total value of the intangible assets.
- From what is left, deduct the total value of the liabilities. What is left are the net tangible assets or net asset value.
Consider the following simple example:
- Balance sheet total assets: $5 million
- Total intangible assets: $1.5 million
- Total liabilities: $1 million
- Total tangible assets: $2.5 million
In the example above, the total assets of Company ABC equal $5 million. When the total intangible assets of $1.5 million are deducted, that leaves $3.5 million. After the total liabilities are deducted, which is another $1 million, only $2.5 million is left, which is the value of the net tangible assets.
Asset Valuation – Valuing Intangible Assets
Intangible assets are assets that take no physical form, but still provide a future benefit to the company. They may include patents, logos, franchises, and trademarks.
Say, for example, a multinational company with assets of $15 billion goes bankrupt one day, and none of its tangible assets are left. It can still have value because of its intangible assets, such as its logo and patents, that many investors and other companies may be interested in acquiring.
Methods of Asset Valuation
Valuing fixed assets can be done using various methods, which include the following:
1. Cost Method
The cost method is the easiest way of asset valuation. It is done by basing the value on the historical price for which the asset was bought.
2. Market Value Method
The market value method bases the value of the asset on its market price or its projected price when sold in the open market. In the absence of similar assets in the open market, the replacement value method or the net realizable value method is used.
3. Base Stock Method
The base stock method requires a company to keep a certain level of stocks whose value is assessed based on the value of a base stock.
4. Standard Cost Method
The standard cost method uses expected costs instead of actual costs, often based on the company’s past experience. The costs are obtained by recording differences between expected and actual costs.
To learn more, check out CFI’s Business Valuation Modeling course.
Importance of Asset Valuation
Asset valuation is one of the most important things that need to be done by companies and organizations. There are many reasons for valuing assets, including the following:
1. Right Price
Asset valuation helps identify the right price for an asset, especially when it is offered to be bought or sold. It is beneficial to both the buyer and the seller because the former won’t mistakenly overpay for the asset, nor will the latter erroneously accept a discounted price to sell the asset.
2. Company Merger
In the event that two companies are merging, or if a company is to be taken over, asset valuation is important because it helps both parties determine the true value of the business.
3. Loan Application
When a company applies for a loan, the bank or financial institution may require collateral as protection against possible debt default. Asset valuation is needed for the lender to determine whether the loan amount is covered by the assets as collateral.
4. Audit
All public companies are regulated, which means they need to present audited financial statements for transparency. Part of the audit process involves verifying the value of assets.
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Related Readings
Thank you for reading CFI’s guide to Asset Valuation. To keep learning and advancing your career, the following CFI resources will be helpful:
