Depending on the situation, fixed assets can have a significant impact on the value of a company. Determining the value of fixed assets can also help assess the value attributable to intangible assets, open the door for borrowing opportunities, or enable management to save on insurance and taxes. Understanding when fixed asset appraisals are required or beneficial enables management to make informed, strategic decisions.
Appraisal vs. Valuation
In many cases, the terms appraisal and valuation are used interchangeably. In the world of business valuation, appraisal generally refers to an estimate of the value for tangible assets such as real estate, equipment, and other types of property. Valuation generally refers to an estimate or calculation of the value of a stock or security.
Why Are Fixed Asset Appraisals Necessary?
The value of a fixed asset recorded on the balance sheet is generally defined as the book value of the asset. The term value is relative and has many different definitions. Depending on the situation, book value isn’t always the best definition of value. The book value of assets, other than land, is generally depreciated over time to account for wear and tear on the asset. Land is not depreciated over time because it is considered to have an unlimited useful life. The systematic depreciation of assets for financial reporting or tax purposes on the balance sheet often skews the value of an asset.
For example, when an asset is purchased and recorded on the balance sheet, the book value of the asset is considered equal to the fair market value of the asset. The fair market value represents the value at which a hypothetical buyer would purchase the asset from a hypothetical seller; in this hypothetical, the purchase price represents the fair market value. As time goes on and the asset is systematically depreciated, the book value will differ significantly from the fair market value.
Appraisals are used to adjust the book value of an asset listed on the balance sheet to the correct definition of value relative to the event triggering the need for an appraisal. However, this adjustment isn’t always necessary, and appraisals represent additional costs to the company. Identifying situations in which an appraisal may be beneficial helps management determine when an appraisal is worth the additional cost.
Reasons to Obtain a Fixed Asset Appraisal
Appraisals and the Asset Approach
Most business valuation methodologies that require a fixed asset appraisal represent some form of the asset approach. The asset approach is one of three major approaches used to determine the value of a company. This approach generally captures the intrinsic value of the company’s assets minus any liabilities. The asset approach is frequently used to value companies that are in very early stages, are approaching liquidation, or hold a significant number of fixed assets.
Most companies that are both pre-revenue and pre-financing haven’t created a lot of value; therefore, most of their value lies in the company’s assets. Companies at this early stage often lack a steady track record, market share, operating synergies, and technology. This essentially means someone with a similar idea could recreate the business by acquiring the same or similar assets owned by the company. Increased sales, acquired market share, and development of both strategic and technological advantages create value for the business, therefore the overall value of the business is less dependent on the value of the fixed assets.
Companies that have stopped creating value and are no longer competitive in the marketplace are at risk of liquidation. As mentioned previously, the liquidation value is usually considered to be the floor of a company’s value because it usually only represents the combined value of the individual assets as if they were sold on the open market minus any liabilities.
Certain companies derive most of their value from their fixed assets. Real estate portfolios derive a significant portion of their value from the individual property values in their portfolios. A significant amount of the value in manufacturing companies comes from large amounts of advanced machinery. The asset approach should be considered in some form whenever valuing companies with a large amount of fixed assets.
The asset approach can be useful when valuing very early stage companies, struggling companies, and companies with a large amount of fixed assets. Although there are some alternatives, fixed asset appraisals are generally the best way to determine the value of assets when using the asset approach to value a company in these categories.
Fixed assets are important when determining the value of a company. Understanding the correct definition of value when valuing a company enables both valuation professionals and management teams to make informed decisions and arrive at more accurate conclusions. Important reasons to look at obtaining an appraisal include insurance, borrowing, taxation, gift and estate, impairment, liquidation, and mergers and acquisitions. Fixed asset appraisals should also be considered whenever the asset approach is used in a valuation, particularly when a company is prefinancing, underperforming, or holds a significant amount of fixed assets that drive value.
This article is purely informative, and Scalar does not accept any responsibility for action taken based on the content of this article.