One approach to business valuation involves direct estimation of the value of the net assets to be acquired (=assets to be acquired by the buyer minus any liabilities to be assumed by the buyer). An asset-based approach typically begins by examining the firm’s balance sheet. However, there are several reasons why book (recorded) values are typically unsatisfactory indicators of business value:
- Book values reflect the accumulated effects of applying Generally Accepted Accounting Principles to the past transactions of the firm and have no necessary connection to current economic value.
- Book values may not reflect the impact of changing prices (inflation) or technological change.
- Balance sheets may not include all the relevant assets of the business, especially unrecorded intangible assets.
Given these deficiencies, the analyst attempts to adjust book values to arrive at an overall business valuation. The analyst examines and values each asset and liability to estimate its fair market value, using techniques such as the determination of market values for comparable assets, expert appraisals, and price index-based inflation adjustments. It is important to identify and value unrecorded intangible assets, including goodwill, and unrecorded liabilities, such as environmental liabilities, operating leases, and other off-balance-sheet and contingent obligations.