One way to value an enterprise is to determine the value of its assets. Here are four approaches to asset-based valuations:
1. Equity book value,
2. Adjusted book value,
3. Liquidation value, and,
4. Replacement value.
Equity Book Value
Equity book value is the simplest valuation approach and uses the balance sheet as its primary source of information. Here's the formula:
Equity Book Value = Total Assets - Total Liabilities
Example: Amalgamated Hat Rack
Total assets $3,635,000
Total liabilities $1,750,000
Equity book value = Total Assets - Total Liabilities = $1,885,000
In other words, reduce the balance sheet (or book) value of the business's assets by the amount of its debts and other financial obligations, and you have its equity value.
This equity-book-value approach is easy and quick. And it is not uncommon to hear executives in a particular industry roughly calculating their company's value in the context of equity book value.
For example, one owner might contend that his or her company is worth at least book value in a sale because that was the amount that he or she had invested in the business. But equity book value is not a reliable guide for businesses in many industries. The reason is that assets are placed on the balance sheet at their historical costs, which may not be their value today. The value of balance0sheet assess may be unrealistic for other reasons as well. Consider Amalgamated assets:
- Accounts receivable could be suspect if many accounts are uncollectible.
- Inventory reflects historic cost, but inventory may be worthless or less valuable than its stated balance-sheet value (or "book" value) because of spoilage or obsolescence. Some inventory may be undervalued.
- Property, plant, and equipment net of depreciation should also be closely examined - particularly land. If Amalgamated's property was put on the books in 1975 - and if it happens to be in the heart of Silicon Valley - then its real market value may be ten or twenty times the 1975 figure.
The preceding are just a few examples. For many reasons, however, book value is not always true market value.
1. Equity book value,
2. Adjusted book value,
3. Liquidation value, and,
4. Replacement value.
Equity Book Value
Equity book value is the simplest valuation approach and uses the balance sheet as its primary source of information. Here's the formula:
Equity Book Value = Total Assets - Total Liabilities
Example: Amalgamated Hat Rack
Total assets $3,635,000
Total liabilities $1,750,000
Equity book value = Total Assets - Total Liabilities = $1,885,000
In other words, reduce the balance sheet (or book) value of the business's assets by the amount of its debts and other financial obligations, and you have its equity value.
This equity-book-value approach is easy and quick. And it is not uncommon to hear executives in a particular industry roughly calculating their company's value in the context of equity book value.
For example, one owner might contend that his or her company is worth at least book value in a sale because that was the amount that he or she had invested in the business. But equity book value is not a reliable guide for businesses in many industries. The reason is that assets are placed on the balance sheet at their historical costs, which may not be their value today. The value of balance0sheet assess may be unrealistic for other reasons as well. Consider Amalgamated assets:
- Accounts receivable could be suspect if many accounts are uncollectible.
- Inventory reflects historic cost, but inventory may be worthless or less valuable than its stated balance-sheet value (or "book" value) because of spoilage or obsolescence. Some inventory may be undervalued.
- Property, plant, and equipment net of depreciation should also be closely examined - particularly land. If Amalgamated's property was put on the books in 1975 - and if it happens to be in the heart of Silicon Valley - then its real market value may be ten or twenty times the 1975 figure.
The preceding are just a few examples. For many reasons, however, book value is not always true market value.
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