It’s important to understand what your business is worth. Sure, you may already know what your cash flow looks like or how your company is doing budget-wise. But, when was the last time you took a look at your asset value?
Your balance sheet is a critical tool to understanding what your business assets are worth. The problem is, the information on it can be misleading because not all assets are valued the same way.
If you learn the basics of asset valuation, you’ll have a better sense of your business assets’ actual value. But, first, what is an asset valuation?
What is asset valuation and why does it matter?
As the name implies, asset valuation is a process to determine the actual value of current assets. This is then applied across your entire business, giving you a clear picture of how much your business assets are actually worth.
For example, an asset valuation would look at the market price of any materials you own to determine a fair value price for them. Next, it might look at any real estate you own, taking into consideration the real estate’s historical value, present value and projected growth to determine what it’s worth.
This process continues, looking at any assets associated with your business, including stocks and intellectual property. These values are then totaled to determine the value of your total assets.
This process is important as it gives you an idea of your company’s overall worth. Other measurements, like cash flow analysis, can give you an idea of your more immediate worth or spending power. These measurements are helpful for your day-to-day operations, but asset valuation is important if you’re looking to sell your company or get business insurance.
Types of assets to value
Some of your business assets are stated at fair market value, which is the price at which they’d sell in a healthy market. Most, however, are not. U.S. accounting standards tend to be quite conservative, so when in doubt, accountants usually understate your financial position rather than overstate it.
The value of assets on the financial statement are often reduced (or “written down”) but can rarely be written up. And, some aren’t measured at all.
This means your company assets can be worth a whole lot more than their book value. To get a better idea of how much your assets are worth, look over the following categories to determine which of these assets you own and how you should determine their worth.
Property, plant and equipment
These include office space, computer equipment, furniture and machinery your company has purchased. These assets are recorded at their purchase cost less accumulated depreciation.
Accountants record a portion of depreciation expense every year based on the estimated useful life of the asset. Property, plant, and equipment can be written down if their value drops dramatically, but they can’t be written up if their value increases.
Any land your business owns is recorded at historical cost. Because land usually has an unlimited useful life, generally accepted accounting standards mandate that land is never depreciated. It’s also never written up, even if its fair market value increases.
Inventory is anything that you purchase with the intent of reselling. Inventory is recorded at the price that you paid for it. It must be written down to market value if it becomes obsolete or damaged, or if its value otherwise drops. It cannot, however, be written up.
Securities that the company has invested in or purchased to trade on the market, and securities available for sale are reported at their fair market value. Typically, this is the value that they’re currently trading for on the stock market.
Goodwill represents intangible assets that give your company extra value. A loyal customer base, a skilled team of engineers and excellent brand recognition are all examples of goodwill.
For most companies, these intangible assets are not measured or recorded at all. The only time goodwill is calculated is when a company is acquired or sold.
Asset valuation methods
When determining the value of assets, there are multiple approaches you can take. Each approach offers something different and has varied usability, depending on the situation. Read each one carefully to see which approach is most appropriate for your company.
Net asset valuation
The net asset valuation is one of the most common valuation methods. With this method, you use the book value of your company’s tangible assets. This is the amount you’ve valued the assets at in your company’s books or balance sheet.
Next, you subtract the total liabilities and intangible assets from your tangible assets. Intangible assets can include things like intellectual property, goodwill, trademarks, copyrights and brand recognition.
This will give you the net asset value, which is essentially the bare minimum of your company’s worth. So the formula for net asset value is:
Net asset value = book value of tangible assets – total liabilities and book value of intangible assets
This can vary from your market value because it’s not factoring in stock prices or your intangible assets, which can sometimes be incredibly valuable, especially if you own valuable patents or copyrights.
Relative valuation method
This valuation approach involves looking at those competing in your space to determine what your relative value is. This method can be effective for getting a realistic idea of how you stack up against the competition, which can be particularly useful if you want to attract investors or sell your company.
To determine your relative value, you can use a number of methods to see how your company compares. If your company is publicly traded, you can look at the value of a competitor’s stocks versus your own. If you’re not publicly traded, you can instead look at similar assets between your company and a competitor.
To find your stock value using relative valuation, use the following formula:
Price-to-earnings = stock price ÷ earnings per share
With your price-to-earnings (P/E), you can look at the market and compare competitor’s P/E against yours. The lower the P/E ratio, the less value the company and stock have.
For example, you can compare the real estate value of a competitor’s location against your own, and then factor in any publicly available financial reporting your competitor has made available. This won’t give you a 100% accurate idea, but it can at least help you see how your company stacks up on the surface.
A professional appraiser can come in handy here, as they will be able to do more investigative reporting for you and give you a more accurate idea of how your company compares.
A liquidation valuation is used to determine the value of the company as if it were being liquidated and sold in the near future. This is useful if you’re planning on selling your company soon or if you simply want a quick idea of how much your company could feasibly sell for at that moment.
To determine your liquidation value, ignore future cash flows and instead look at your tangible assets. Determine their market value to get an idea of their immediate value. This includes any real estate your company owns, as well as items like office supplies. Then total up the value of your tangible assets for your liquidation value.
Liquidation value = auction value – liabilities
For example, say your company has liabilities of $200,000. You then look at the book value of your assets and have them assessed for auction value. They’re valued for auction at $500,000. Next, you subtract the liabilities from your auction value, giving you a liquidation value of $300,000.
This doesn’t factor in any intangible assets, as they can be harder to pin a value on, and in some cases, harder to sell. But, this will give you an idea of how much your company is worth in the short term. Just know that this value is likely a little low, as your intangible assets could be worth an additional amount.
Knowing your worth
Knowing the value of your assets is an integral part of general business valuation. It’s also essential for keeping tabs on your business’s health because it helps you stay aware of whether or not your overall value as a company is growing.
Asset valuation can take time, but with proper planning, you can become a pro at it. Reference existing business documents to make life a little easier, go slowly and remind yourself that this entire process is only possible because you started your own business in the first place.
You’ve made it this far, you can make it through an asset valuation. Besides, how else can you brag to your friends that your business is worth more than it was a year ago?