Asset-based Valuations: Valuation Floor or Flawed Valuation?

Economic & Financial Consulting

May 5, 2017

Asset-based valuations, such as ‘book value’, are often applied in one of two ways: (1) as a floor or cross-check for values assessed using Discounted Cash Flow (DCF) or market-based approaches; or (2) to value assets not reflected in a DCF or market valuation, such as nonoperating assets. However, the utility of these applications is sometimes misjudged because of misunderstandings about the content of financial statements – in particular, because the requirements (or ‘financial reporting standards’2) governing the preparation of financial statements have changed and become more complex in recent decades.

In this article, we discuss the application of asset-based methods and, in particular, why asset values and related information in financial statements both need to be carefully assessed as part of an overall valuation or damages analysis.

Background

An asset-based valuation is a method of valuing an entity as the sum of the value of each of its assets and liabilities. Strictly speaking, it does not represent a valuation approach3 (such as the market, income and cost approaches, which are based on economic principles of price equilibrium, anticipation of benefits or substitution4). Rather, an asset-based methodology provides a framework in which individual assets and liabilities are identified and valued, but which does not specify the approach(es) to apply when valuing those assets and liabilities.

Asset-based valuations are often performed using balance sheet information from the financial statements of an entity. This connection to financial statement information (particularly where that information has been independently audited) is sometimes considered attractive to tribunals because of a perception that such information is comprehensive and reliable and can, therefore, be used directly in the valuation or damages analysis. However, as we explain in this chapter, financial reporting standards govern the recognition and measurement of assets and liabilities, and the details of these standards need to be considered carefully when applying an asset-based approach.

Notes:
2 References to financial reporting standards in this article are predominantly to International Financial Reporting Standards (IFRS), although similar issues may arise under other financial reporting regimes.
3 Paragraph C14 of the 2011 edition of International Valuation Standard (IVS) 200: Business and Business interests.
4 Paragraph 55 of the International Valuation Standards Framework.

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Mark Bezant

Senior Managing Director, Head of EMEA Economic & Financial Consulting

David Rogers

Managing Director