Asset-Based Valuation Methods

Imagine you're a landowner looking to sell your property in Goa. When you set the price, you don’t just consider how the property is performing today or how much rent it generates. Instead, you focus on the underlying value of the land itself — the total worth of the property’s physical assets, including the land, buildings, and any equipment. This is very similar to Asset-Based Valuation Methods (ABV) used to value companies.

What is Asset-Based Valuation?

Asset-Based Valuation focuses on evaluating a company based on the value of its underlying assets. In other words, the company is valued by adding up the worth of everything it owns: real estate, equipment, inventory, and other tangible and intangible assets. This approach is particularly useful for asset-heavy businesses, like real estate firms, manufacturing companies, and holding companies, where the value of assets plays a significant role in the overall worth of the company.

There are two main methods of Asset-Based Valuation:

1. Book Value Method
   
2. Liquidation Value Method
   

1. Book Value Method

This method involves determining the company’s total net assets by subtracting liabilities from assets, based on historical cost accounting. It is the simplest form of asset-based valuation and is found on the company’s balance sheet.

Formula: Book Value = Total Assets − Total Liabilities

Example: If a manufacturing company has total assets of ₹50 crore (including land, machinery, and buildings) and liabilities of ₹20 crore (such as loans and payables), its book value would be:

Book Value = ₹50 crore − ₹20 crore

Book Value = ₹30 crore

This ₹30 crore is the net worth of the company, based purely on its physical and financial assets.

2. Liquidation Value Method

This method assumes that the company is being liquidated, i.e., all assets are sold off, and liabilities are settled. The liquidation value is the amount the company could sell its assets for in a forced sale, and it’s usually lower than the book value because assets may need to be sold quickly or at a discount.

Example:

If the same manufacturing company had a liquidation scenario, where it could only sell its machinery and buildings for ₹40 crore and its liabilities are ₹20 crore, the liquidation value would be:

Liquidation Value = ₹40 crore − ₹20 crore

Liquidation Value = ₹ 20 crore

Where is Asset-Based Valuation Most Useful?

• Asset-heavy industries: Real estate, natural resources, and manufacturing businesses
  

• Distressed companies: Companies in financial trouble or bankruptcy proceedings
  

• Private companies: Where market-based methods are not available due to lack of public data
  

Limitations of Asset-Based Valuation:

• Does not consider the company's future earnings potential, which can be more valuable than its physical assets.
  

• Not suitable for service-based businesses or tech companies where intangible assets (e.g., intellectual property, brand value) dominate.
  

• May undervalue a company during periods of low asset market prices (e.g., during a market crash).
  

In India, asset-based valuations are often used for companies like Steel Authority of India Limited (SAIL) or Indian Oil Corporation (IOCL), which own significant physical assets like factories, refineries, and land.

Asset-Based Valuation is like pricing a piece of property by its land, buildings, and equipment. It gives you a clear idea of what the company owns but doesn’t take into account how well the company might be performing in the future. In the next chapter, we will dive into Market Capitalization and Enterprise Value, two key metrics used to value companies in the stock market.