Friday, 23 April 2010

How much should you pay for a business? Valuing a company (2)

Asset value

An obvious starting point for valuing a company is to look at the asset base of that organisation. On this basis the company would be worth its net asset value. There are some limitations to this approach:

Book value - Accountants usually value fixed assets at what they cost, depreciated to reflect the reducing value as items are worn out in use. Book value may not be an accurate reflection of the real value.

  • This can apply when land and buildings were bought some time ago, and have grown in value; or 
  • if the value of these assets has reduced significantly since purchase, due to new technologies. 
  • There may also be a factor that has previously been ignored, such as environmental issues. Disposal or land remediation costs could wipe out any asset value.

Normally a company will have a fixed asset register that lists all its assets, and the current depreciated book value of those assets. A similar register might also exist for its other assets.

Working capital - Again, we must understand whether these items are accurately stated.

  • Stock (inventory) is usually valued by accountants at what it cost. This may be far more than we can sell it for, especially if it is out of date. 
  •  Debtors (receivables) is money owed to us by customers. How much of this might be bad debt (i.e. invoices that may never get paid)? 
  •  Creditors (payables) is money we owe our suppliers. How much has our company avoided paying to improve its cash flow?

Intangible assets - This can take the form of

  • goodwill (the difference between what we pay for an acquisition and what the assets are valued at) or 
  • capitalised costs (such as research or start-up costs).
As there are no physical assets to underwrite these, the net assets may be overstated if these elements are high.

Investments - There might be some investments in other companies, which accountants will value at what was paid for them, rather than their realisable value in the market.

Unstated assets - Accountants usually put no value in the books on such things as people, brands, intellectual property, market position, forward order book etc. This means that the net asset figure alone might seriously understate the company value. This can apply especially in service-based businesses that have few tangible assets.

Also read:

Valuing a company (1)

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