Asset Base

What Is an Asset Base?

The asset base is the value of the assets owned by a company. It gives intrinsic value to a business.

However, the value of these assets is generally not static. Instead, it fluctuates because of the appreciation and depreciation of the assets. Also, the total asset base value changes because of the buying and selling of assets.

The features include:

• It is an important factor in terms of the valuation of a company
• It includes fixed assets such as buildings and machinery and financial assets such as cash, cash equivalents, securities, etc

Generally, the asset base of the company is less than the market value of the company. This is because market value includes intangible assets, such as future cash flows.

What is Book Value?

A company's book value is essentially the net value if all the assets are sold and liabilities are paid off. Book value is generally used interchangeably with asset base.

A company’s book value is located in the company's financial statements (basically in the balance sheet).

Theoretically, book value refers to the difference between the company's total assets and total liabilities.

The equation for book value can be shown as:

Book Value = Total Assets - Total Liabilities

Sometimes analysts or accountants exclude the value of intangible assets from the book value because sometimes, the value of intangible assets can’t be realized.

For example, Company ABC has a total asset value of $10 billion and a total liability value of $8 billion. Therefore, the book value of the company is $2 billion.

This indicates that if the company sells off its assets and pays down its liabilities, the equity value of the business would be $2 billion.

Now, let’s look at an example through a mock balance sheet:

Hence,

Book Value = $910 Million - $740 Million = $170 Million

What is Asset-Based Valuation?

This is also commonly used for company valuation purposes. It gives a transparent picture of what the company owns and owes.

The formula for this method of valuation resembles the formula of this itself. However, it includes the value of items that are not recorded in the balance sheet but, rather, in the footnotes of the balance sheet, such as patents and contingent liability.

For example:

Given items of Company ABC,

Hence, 

Total Owner’s Equity, or Valuation = ($32 - $28) = $4

Asset-based Approach vs. Cost-based Approach

The asset-based and cost-based approaches are both pricing or evaluating an asset.

An asset-based approach is more beneficial while evaluating a business because it can include the value of tangible and intangible assets.

Whereas the cost-based approach is only useful for valuing or pricing a particular asset owned by a business. This is because it can't value intangible assets such as goodwill, intellectual property, etc.

Asset-Based Valuation Vs. Enterprise Value and Equity Value

The asset-based and enterprise value approaches are methods of pricing or evaluating an asset.

The asset-based approach is known for its accuracy and simplicity in calculation; however, it is not an appropriate method for valuing a business at its market value. This is because it can understate a firm's value if an analyst ignores the value of some or all intangible assets.

In contrast, the enterprise and equity values are appropriate for valuing a business at its market value, as it includes the value of all intangible assets.

Equations for Enterprise Value and Equity Value:

Enterprise Value = (Price per Share * Number of Shares) + Total Debt – Cash

           Equity Value = Enterprise Value + Cash - Total Debt

What does Asset Base indicate?

The base indicates multiple scenarios, such as:

• Although it's common for a company to buy and sell assets for changing business strategies, a large swing in the value of an asset base, be it a huge decrease or increase, with no practical justification as to what management is planning to do with it, acts as a bad indicator for analysts.
• The base is evaluated by banks when considering a company for a loan. A small base implies a low chance of recovering loaned funds in the event of a default.
• It is also an important factor for investors. A disproportionate base can be a red flag for an interested investor.

Conclusion

The asset base is a crucial financial concept when evaluating or checking the creditworthiness of a business. This valuation approach is simple to calculate and gives practical values for making decisions or further projections.

However, there are some drawbacks to this approach which is why it is generally recommended to use this method only when applicable, i.e., when there are little to no intangible assets.

This method can also be used along with other methods of valuation.

Researched and authored by Dhanraj Johari | LinkedIn

Reviewed and edited by James Fazeli-Sinaki | LinkedIn