Asset-Based Approach

What is 'Asset-Based Approach'

An asset-based approach is a type of business valuation that focuses on a company's net asset value (NAV), or the fair-market value (FMV), of its total assets minus its total liabilities to determine what it would cost to re-create the business. There is some room for interpretation in terms of deciding which of the company's assets and liabilities to include in the valuation and how to measure the worth of each. The other two main approaches used for valuing businesses are the market approach, which looks at what similar businesses are worth, and the income approach, which estimates how much money the business might generate in the future.

BREAKING DOWN 'Asset-Based Approach'

The real value of assets in an asset-based approach for valuing a business may be much greater than simply adding up the recorded assets. For example, a company’s balance sheet may not include major assets, such as internally developed products and proprietary methods of conducting business. If the company’s owner did not pay for the assets, they did not get recorded on the cost basis balance sheet. In addition, many businesses have special products or services that make them unique. Pricing those offerings as part of selling a business may be difficult due to their intangible value.

Adjusted Net Asset Method

The asset-based approach is best used when a business is non-operating or has been generating losses, and the company’s focus is on holding investments or real estate. The adjusted net asset method is commonly used for estimating the value of the business. The difference between the fair market value of the company’s total assets and the fair market value of its total liabilities determines the fair market value of the business.

Determining Fair Market Value of Assets

The asset-based approach begins by creating a financial picture of the company through information on the balance sheet. Current asset values may differ dramatically from the assets’ acquisition costs. Although the balance sheet lists assets and liabilities at historical cost, accurately using this method depends on recasting those costs and capturing the current value.

Assets are reviewed and the fair market value of each is obtained. For example, a landowner may work with a real estate appraiser to obtain the land’s fair market value. The owner may discover the land purchased for $1 million 10 years ago is now worth $3 million. The land is then restated at $3 million for the purposes of applying the net asset value method. The process is repeated for each additional company asset.

In contrast, liabilities are typically already stated at fair market value. In most cases, no additional calculations are needed. The fair market values of the assets are added up and the total liabilities are subtracted from the total. The difference is the estimated value of the business.