These valuation methods rely mostly on the value that the company has generated in the past, by appraising the assets and liabilities that a company holds. Valuing a company solely based on its current assets and liabilities disregards its potential to generate gains for its investors. Hence, through this approach we get a static perspective of the company. There are several approaches as a book-value type of valuation:
- Book-value (strict sense).
- Adjusted book-value.
- Patrimonial value.
- Liquidations value.
- Substantial value.
Book-value (strict sense)
Book-value is a concept that comes directly from accounting. In simple terms, it corresponds to the amount of assets that exceeds the liabilities of the company. Identifying book-value is intuitive: you only need to take a quick analysis of the balance sheet. Due to its simplicity, a book-value approach is hardly a reliable estimator of a company’s equity value. The mains critics to book-value are:
- Often (specially in non-public traded companies) accountants and financial managers tend to take a conservative approach while valuing assets and do not adjust the real value of the assets that a company holds. Take tangible assets as example: it is common for companies to hold assets that have been fully (or almost fully) depreciated but that are still operational and if sold could grant some return to the company; in such situations the total real value of assets would be higher, as would be the equity of the company.
- Intangible assets with no foreseen lifetime expectation need to be reappraised regularly. That not always occurs.
- Some current assets do not reflect their true value: it is often seen that inventories do not reflect shrinkage effects and that the receivables do not adequately reflect impairments.
- There may be potential liabilities from legal or environmental processes that are not encompassed in the balance sheet.
It is common to observe book-value combined with other valuation approaches and even if you want to value a company for its historical value, there are adjustment that need to be taken into account, for these may enable a more reliable approach of the company’s reality.
As stated above, one of the faults of the book-value approach is that it is unlikely that the company’s accounting correctly reflects all of its assets, namely the intangible assets. The adjusted book-value comprehends valuing the company’s assets (or at least its main assets) for their fair market value. Item by item the values must be assessed and, if needed, corrected.
Moreover, potential future liabilities that may not be reflected on the balance sheet must be added at their fair value.
The patrimonial value is determined through a fair value valuation of the company’s fixed assets and liabilities, which should be performed by a professional appraiser. The asset valuation is differencing factor towards a book-value valuation. Because in the valuation literature there is not a fully standardized use of nomenclatures, it is common to encounter references to the adjusted book-value that are in fact closer to that of patrimonial value.
Keep in mind that fair market valuation of assets ,such as intangible assets, may correspond to the benefits that those assets bring to the company. If sold, those assets may not provide the same return for other companies, hence their patrimonial value may be lesser for and acquirer or even null.
Similar to the patrimonial value, the liquidation value considers also the economic value that the company would obtain if it was required to undertake a sale of its assets, but mostly taking into consideration that it would occur in a short-term. This particular fact implies that assets may valued at an inferior value than on a patrimonial basis: there maybe less potential acquirers for the assets in the short period of time.
The substantial value has a different approach from the previous book-value based methods. Instead of measuring the value of the assets that the company holds, the substantial value estimates what an eventual acquirer would be spending if he or she, as an alternative, bought the same assets (or equivalent) that the company holds to create a similar sized business.