Your balance sheet is a critical tool to understand 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 understanding asset valuation, you’ll have a better sense of your business assets‘ actual value.
Asset Valuation Basics
Some of your business assets are stated at fair market value, which is the price at which they’d they would 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.
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 its value drops dramatically, but it can’t be written up if its 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, damaged, or its value otherwise drops. It cannot, however, be written up.
Securities that the company has invested in and/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 at 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.
The book value of your assets and the true value of your assets are two totally different concepts. The book value of your assets provides a conservative estimate of what resources you have, assuming you’re going to continue business as usual. If you’re planning to sell your company, though, you can’t necessarily rely on your balance sheet to determine its value. Instead, talk with a financial professional about obtaining a business valuation.