Adjusted net asset method

This method is used to value a business based on the difference between the fair market value of the business assets and its liabilities. Depending on the particular purpose or circumstances underlying the valuation, this method sometimes uses the replacement or liquidation value of the company assets less the liabilities. Under this method, the analyst adjusts the book value of the assets to fair market value (generally measured as replacement or liquidation value) and then reduces the total adjusted value of assets by the fair market value of all recorded and unrecorded liabilities. Both tangible and identifiable intangible assets are valued in determining total adjusted net assets. If the analyst will be relying on other professional valuators for values of certain tangible assets, the analyst should be aware of the standard of value used for the appraisal. This method can be used to derive a total value for the business or for component parts of the business.

The Adjusted Net Assets Method is a sound method for estimating the value of a non-operating business (e.g., holding or investment companies). It is also a good method for estimating the value of a business that continues to generate losses or which is to be liquidated in the near future.

The Adjusted Net Assets Method, at liquidation value, generally sets a “floor value” for determining total entity value. In a valuation of a controlling interest where the business is a going concern, there would have to be a reason why the controlling owner would be willing to take less than the asset value for the business. This might occur where the assets are underperforming, resulting in a conclusion of value that is less than the adjusted net assets value but more than the liquidation value. Before concluding the Adjusted Net Assets Method has established the floor value, the valuator should consider the potential of overstating the value of assets, the existence of non-operating assets, and other omissions in his/her determination.

The negative aspect to this method is that it does not address the operating earnings of the business. Therefore, it would be inappropriate to use this method to value intangible assets, such as patents or copyrights, that are typically valued based on some type of operating earnings (e.g., royalties). However, replacement cost methodology may be utilized in determining values of certain intangibles such as patents.

Illustration – the following reconciliation between book values and fair market values incorporates four major adjustments:

  1. To remove non-operating assets, for example: excess cash and cash surrender value of life insurance.
  2. To convert LIFO inventory to FIFO inventory.
  3. To estimate NPV of the deferred income tax liability associated with the built-in gain on LIFO reserve and PP&E based on a seven-year liquidation horizon discounted to NPV using a 5% discount rate (risk-free rate).
  4. To adjust property and equipment to estimated fair market value based on an appraisal performed by ABC Appraisals, Inc.

Please Note: In this example, an adjustment for deferred taxes was made. Not making an adjustment for deferred taxes would be theoretically justified in a situation where the analyst is valuing a business for purposes of an Asset Purchase/Sale. However, an adjustment for deferred taxes may be appropriate in a valuation when the shares of the corporation are to be valued and adjustment has been made to adjust the value of assets from historical amounts to an economic/normalized balance sheet.

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