Introduction
The difference between asset valuation and business valuation is often confused to the extent of being escalated to a dispute including even litigation. It is quite common to come across an ordinary shareholder in a company equating the value of total assets owned by the company to the value of the business or the company’s shares. I hope this article will help clarify the difference.
A company’s assets
From an accounting perspective a company’s assets are usually classified into non – current / fixed assets and current assets.
Non – Current Assets
Non – current assets are used by the business for more than 12 months. Examples include land and building, plant and machinery, motor vehicles, computer equipment, furniture and fittings, equity investments, etc.
Non- current assets may also be split into tangible and intangible assets. Tangible assets are physical such as those cited above. On the other hand intangible assets do not have physical presence. Most common examples include goodwill and intellectual property such as patents, etc.
Current Assets
These assets change their form or are used up within 12 months. They are usually included in a company’s working capital. Examples include inventories / stocks (raw materials, work in progress, finished goods), receivables / debtors, prepayments, cash and bank.
Valuation of a company’s assets
Some of you are already familiar with valuation of assets. For example land and buildings are usually valued by independent professional valuers / estate agents. Some of the methods used by such professional valuers in valuing assets include depreciated replacement cost, open market value, forced sale value, etc. Machinery may be valued by professional valuers with the assistance of technical experts who assess the condition of the assets and assign values having regard to the price of brand new ones.
Some companies, as a policy, value their assets regularly, for example annually for purposes of producing audited annual financial statements.
Current assets are usually valued by management. For example inventories are valued by considering the lower of their cost and net realisable value. In most cases a physical stotcktake is done and values assigned to the items based on historical cost. Further, methods that are used by accountants usually include first in first out (FIFO), last in first out (LIFO) or average cost (AVCO).
Receivables / debtors are stated at amounts as billed / invoiced to credit customers less adjustments for bad debts actually written off or provision for doubtful / likely bad debts. Cash and bank are usually stated without adjustment unless recoverability is doubtful, for example if funds in a bank cannot be accessed because the bank is insolvent.
Valuation of a business
I have previously written articles explaining some of the methods used in the valuation of businesses, in other words valuation of shares in a business. Some of the methods include:
- Market approach which can be used to value publicly traded or shares that are listed on a stock exchange such as the Zimbabwe Stock Exchange.
- The earnings approach which included the Discounted Cashflow Method (DCM) method, also known as the Net Present Value (NPV) method, and the capitalisation of past earnings.
- Another method involves using the Price Earnings (PE) of comparable companies, usually listed. The PE of the listed company is multiplied by the earnings of a company to estimate the value of that unlisted company.
- Net Assets Mathod, also called the Balance Sheet or Statement of Financial Position method.
It is the Net Asset Method which causes problems. Its use is usually incomplete as only assets are usually considered and liabilities excluded in error.
Net Assets Method
This method is called the Net Assets Method as it estimates the balance / portion of total assets attributable to the company’s ordinary shareholders.
Formula
Total Assets minus Total Liabilities = Net Assets.
Total assets
As explained above Total Assets is the total of both Non – Current and Current Assets.
Total Liabilities
On the other hand Total Liabilities include both long term (non – current) liabilities and short term (current) liabilities. Non – current liabilities are those debts that are due in more than 12 months. Current liabilities are due within 12 months e.g. trade creditors, bank overdraft.
Valuation of an estate
Many people are familiar with the valuation of an estate. Essentially it includes the estate assets and claims (liabilities) against the estate. In a deceased estate it is the net assets, less estate expenses that is distributable to the beneficiaries. This closely approximates net assets in a company that are attributable to ordinary (residual) shareholders.
Sources of confusion in understanding Net Assets
In my view there could be many reasons, some which I explain below.
- Ordinary (residual) shareholders failing to understand or refusing to accept that what they own are shares in a company and that the assets are instead and in fact owned by the company. Many ordinary shareholders of especially owner managed companies think they own the assets and the company is just a vehicle. It is difficult to explain to them that they are separate from the company, that the company owns the assets instead, that if the company has debt the creditors have a claim on the company assets. At times this is despite the fact that some of the creditors may have caused the company to be declared insolvent due to the non-payment of creditors.
- Creditors are viewed as outsiders and will be treated in some way and go away. While it is correct that creditors are not shareholders they indeed are key stakeholders as they can claim part of the company’s assets through legal processes in the event of insolvency or default on debt.
- Failure to understand accounting and finance especially the interpretation of financial statements. For example it may be difficult to interpret the Statement of Financial Position on aspects such as Shareholders’ Funds / Equity, being the total of Share Capital and Reserves. This usually approximates the value of the ordinary shares based on the net Assets Method.
Conclusion
An appreciation of business accounting and finance will go a long in addressing this confusion including resolving legal disputes.
Disclaimer
This simplified article is for general information purposes only and does not constitute the writer’s professional advice.
Godknows Hofisi, LLB(UNISA), B.Acc(UZ), CA(Z), MBA (EBS, UK) is a legal practitioner / conveyancer, chartered accountant, corporate rescue practitioner, and consultant in deal structuring and is an experienced director of companies. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
