Asset Based Method Of Valuation – Just as there are many reasons to seek a business appraisal, there are many different types of valuation methods that can be used to calculate a fair and defensible value for a business or asset. Choosing the best valuation method is the first step in determining the value of your business or business assets. There are several considerations that must be taken into account when determining the type or types of appraisal to use in a particular case, including the reason for the appraisal, the industry and the characteristics of the particular business. Many cases require a combination of valuation analysis methods to arrive at a defensible value. In this article, we will examine the different valuation techniques that are most used and accepted in accounting practice, and which are most suitable for each purpose. Valuation Objectives Some situations require determining the current economic value of the company: Want to sell the business due to retirement, divorce or health or family reasons Need debt or equity financing to underwrite expansion or solve cash flow problems. Partners or LLC members Sale of part of the business by partners or members Calculation of the value for tax purposes The reason for carrying out the assessment will determine the scope of the value analysis – it is to determine the property value for property tax purposes, or it is the business value for the purpose of determining advertising? The reason for the evaluation provides the necessary data points to use the best evaluation analysis method. (Tweet this!) Need an experienced analyst to help determine the most appropriate pricing method – and provide an expert value opinion? Schedule a free discovery call with. Types of Valuation Methods Three types of valuation methods are commonly used to assess the economic value of a business: market, cost and income; each method has advantages and disadvantages. In the following sections, we explain each of these assessment methods and their respective conditions. We will also look at examples in the energy industry to show how each method can be used to value different types of business activities. Market Valuation Methods There are basically two market approaches to valuing a business. The first depends on finding comparable companies, analyzing price/earnings ratios and other value indicators, creating averages and applying them to the subject company. This is obviously an imprecise way to assess value, due to the fact that the market can go down or the company can go up. Also, it is difficult to estimate how much multiples differ between similar companies due to individual company-specific factors. The second market value approach is similar to using comparable properties. This approach depends on the analysis of sales of similar properties, and shows the cash value by analyzing new sales analysis or offering similar company prices. If the same transaction is not identical to the subject business, the sale price of the comparable property will be adjusted to reflect the difference from the subject business. In our example, a power plant can be valued using the market value method. Using a market approach may require looking at recently built plants in the same market, rather than looking for deals that are few and far between. If there are no comparable assets on the market, plants currently under construction or approved for construction can be used for comparison. As in real estate appraisals, comparable plants should be adjusted to reflect the differences of the plants you are trying to value. For example, in real estate appraisal, if you use a comparable home that has 3 bedrooms and a comparable property that has 2, the sales price of the comparable home will be adjusted for the additional bedroom. The same principle applies to power plants. These assets can have different lives; Evolution Environmental and public policy regulations have a great impact on value. For example, if the plant being priced is coal-fired, there may be environmental or regulatory issues that make coal-fired power plants economically unfeasible. There are some disadvantages to the market approach. In many situations, the market may not be active enough to provide sales data on comparable properties, and there may not be reliable sources to provide independent value verification. For the valuation of large, complex, income-producing properties, a comprehensive analysis of equally complex transactions; not only are there fewer of these transactions, but information related to the economic factors that influence buyers’ decisions in these transactions is not available through public records. These types of transactions often involve the purchase of intangible assets such as trademarks, patents, preferential agreements, trade secrets and customer relationships. The fair value of the asset is unclear to outsiders not involved in the sale. To be useful for comparison purposes, the sales price of a comparable company must identify its components of value—tangible versus intangible assets, real versus personal property, and taxable versus nontaxable assets. Although appraisers provide several elements of value, the complexity of factors can make sales a less reliable indicator of a company’s value. And even when all the necessary information is available, the process of value adjustment for comparators and subject companies is subjective, thus producing a value that is not as solidly defended as one calculated by another valuation technique. For these reasons, the market valuation method can provide some useful data points about the “going rate” for a similar business at a given time – but in many cases it is unable to accurately estimate the fair value of the company. However, the market approach is sometimes used as a merger and acquisition (M&A) valuation technique. In M&A transactions, the acquiring company often hopes to achieve some kind of business synergy by acquiring the subject business, and as a result, it is not important to assess the exact value of the subject company during purchase negotiations. The market value approach is also one of the most widely used valuation techniques in finance. Cost assessment method The cost approach is based on the logic of the principle of substitution. The concept is that a prudent investor will not pay more for a property than an equivalent replacement property. As with the market approach, there are two potential starting points for the cost approach to valuation: reproduction costs and replacement costs. Reproduction cost is the estimated cost, at current prices, to create an exact replica of the subject property, with the same materials, construction techniques and standards, design, and quality of workmanship, and all defects, adequacy and adequacy of the same property. obsolescences to this exact duplicate. Replacement cost is the cost of replacing an existing property with a new one of the same utility, on a specified date. For obvious reasons, replacement costs are more useful in terms of the principle of substitution; a wise investor will not choose to replicate an existing property and incorporate obsolete, redundant or unused features. Using the example of the power plant case, if a company is considering buying a plant that serves 100,000 people, it will pay no more for the existing plant than it would spend to build a new plant to serve the same 100,000 people. The cost of a new plant can be determined by determining the cost of materials and the cost of construction. The cost of building a modern, functionally similar plant is usually much lower than the reconstruction of an existing plant. New factories can be built in a cheaper, more efficient way, using the latest materials and construction techniques and the latest technology. The new plant will eliminate obsolete and less efficient equipment. In addition, new plants avoid cumulative capital maintenance costs that create “ghost assets”—assets that exist but are not used for functional capacity—on the books. The cost is then adjusted by depreciation to arrive at the current replacement value minus the depreciation of the subject power plant. One advantage of the cost approach is that it is a solid capital valuation method supported by current market costs and the operating environment. This gives a clear value to the property, as the value is clearly separated from all other assets. Used in conjunction with the income approach, the cost approach allows intangible assets to be valued indirectly. The present value established by the cost approach is subtracted from the enterprise value determined by the income approach; the rest is the value of intangible assets. In terms of limitations, the cost approach requires a lot of reliable data. It requires calculating the cost of materials, equipment and labor, and, for example, developing information about the most efficient way to serve these 100,000 customers. Finding and developing this information is very data and time intensive. Income evaluation method
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