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Asset valuation: meaning, methods and more

For businesses, understanding the value of their assets is paramount for accurate financial reporting as well as for decision making. Asset valuation is a way to understand the company’s financial health beyond revenue and expenses. In this article, we provide an introduction to asset valuation. We explain what it brings to organisations and gauge the pros and cons of the approach. We also elaborate on the different asset valuation methods to give you a well-rounded view of asset valuation so that you can pick the right one for your business.

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What is asset valuation?

To understand the value of a business, you need to know the value of its assets. This could be the value of the company stocks, the value of the building and equipment and even less tangible assets such as brand recognition or the customer pool. In this section, we clearly define what asset valuation is, provide you with the reasons why it is important for your company and outline the pros and cons of asset valuation.

A definition of asset valuation

Asset valuation is the process of calculating the market value of the business’ assets. This means that both tangible and intangible assets are considered. Understanding these two types of assets is essential for getting a holistic overview of asset valuation.

Tangible assets

Tangible assets are easier to qualify and quantify. They include the machines, buildings, land and cash in the bank that a company possesses. They also include the value of any stocks. Tangible assets are necessary to understand tax payments, secure loans or even for auditing.

Related: What Is the FSB? How the federation of small businesses can help

Intangible assets

Compared to tangible assets, intangible assets are more subjective and measuring them might be more of a challenge. Intangible assets refer to elements that are not physical such as the logo, the brand, the customer pool and much more. These assets are essential to understand the health of a company, particularly when it is being insured, sold or when it is subject to a merger.

Both tangible and intangible assets should be considered when conducting an asset valuation.

What asset valuation brings to your business

Asset valuations may sound cumbersome but are of significant value for businesses. Here’s why:

Knowing the right price

Asset valuation is what allows the organisation to know its value. This can be particularly beneficial when a business is being sold. In this instance, both buyer and seller want to make informed decisions that they can get from the asset valuation data. With time, regular asset valuations can provide valuable information on the development of your business.

Read more: What is organisation development?

Looking into company mergers

Company mergers happen all the time. Asset valuations allow the merging organisations to determine the value of both businesses.

Applying for a loan

When a business wants to apply for a loan, they need to show their financial situation. Asset valuation allows to put forward collateral against possible debt default. In other words, the loan lender uses the asset valuation to understand if the loan amount is covered by the assets as collateral.

Presenting auditing statements

Most companies need to present audited financial statements. These statements aim to provide financial transparency. Note, although asset valuation refers to financial auditing only, there are many more types of auditing that an organisation can conduct. For example, take a look at how to conduct an ethics audit.

Pros and cons of asset valuation

There are some pros and cons to asset valuation. Knowing these will help you gauge if asset valuation is appropriate for your situation.

Pros of asset valuation

  • Asset valuation is the most preferred approach for mergers and acquisitions or even for liquidation.
  • The process can be straightforward and follow mathematical formulas.
  • Asset valuation considers elements that are not in the balance sheet.

Cons of asset valuation

  • The process does not account for the profitability of the business and there may not be correlation between asset valuation and business success.
  • The valuation of intangible assets may be a complex project that requires acute attention to detail.
  • The evaluation needs to be conducted at different times to consider market fluctuations.

Asset valuation methods

When thinking about asset valuation, there are two aspects to consider. The first one is the methodology for the asset valuation whereas the second relates to the scope of the valuation, that is to say which assets will be part of the valuation.

The methodology should be chosen based on the context. The most common are the cost method, the market approach and the income approach, but there are also others available. We provide more detail on some of these methods below.

The cost method

The cost method for asset valuation is straightforward. It uses prior acquisitions that the company has made to assess its value. The asset values are determined based on the amount paid at the time of the acquisition and include any additional fees such as installation or delivery. The objective of this approach is to use easy and traceable information. It is factual and brings historical accuracy. The method makes asset tracking and auditing easy but does not account for market changes or the condition of assets. It is preferred for markets with low volatility.

The market value method

The market value method focusses on the value of an asset based on its market price. It employs real data from the active market to extract value. The main benefit of this method is that it is a real-time asset valuation. It considers market fluctuations and is used to measure stock exchanges and commodity markets. This method can lead to volatility and can be time consuming as it requires current data. It is recommended to use it in finance, real estate and technology as assets in these fields tend to change value according to market trends.

The base stock method

The base stock asset valuation method is an inventory valuation technique. It assumes that organisations maintain a minimum inventory, also referred to as a base inventory, at all times. This stock is a safety net to meet customer demand. As the method is based on inventory, it is stable and useful in volatile markets. It allows consistent financial reporting. The manufacturing and retail industry often prefer this method.

The standard cost method

The standard cost method for asset valuation is an accounting method. It is similar to the cost method but uses a pre-determined standard cost of an item rather than the acquisition cost. These standard costs take into consideration market analysis and historical data. The method simplifies the valuation of an inventory but doesn’t always align with market values. Businesses should use it when inventory costs are stable and to assist with accounting.

Some methodologies are more appropriate to certain type of assets. The context should also be taken into account as some methods include certain elements that are not considered in others.

When it comes to asset valuation, it is important to know which methods are available and assess which is best. Every business has specificities that need to be accounted for. If there is a lot at stake with the asset valuation, it might be preferable to solicit a specialised organisation that can help with the process.

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