by Joseph Evenson, Staff Accountant
In the business valuation world, due diligence is crucial now more than ever. The “same as last year” mentality is no longer acceptable until we have a few years of stability under our belts. COVID-19 has been, and continues to be, a unique challenge for businesses and business owners.
Some of the challenges we have seen are:
- Uncertainty on business operations
- Changes in the market demand (both low and high)
- Challenges with supply chains and inventory
- Staffing levels for what is needed and what is affordable
These challenges may result in large swings in valuations and could change day to day.
Different from the recession of 2008, COVID-19 has had both winners and losers and the total affect on the economy is yet to be known. There is no historical data to look at to estimate what to expect as an upheaval of this nature has not happened in modern times. Things are changing on a monthly, weekly, and daily basis.
This not only includes how businesses are operating, but also the value of those businesses themselves. As valuators, we have to give consideration to those changes specifically related to the various methods used in valuation, including the asset approach.
What is the Asset Approach?
The asset approach is a form of valuation that focuses on the value of a company’s assets or the fair market value of its total assets after deducting liabilities. Complexity arises because there is likely no balance sheet shown at exact fair-market-value.
Thus, the valuator must “mark-to-market” the balance sheet. These adjustments can be discretionary and will vary depending on who does the valuation. However, if the assets on the balance sheet are common, one can generally find the same or similar comparable assets to support their valuation.
The main benefit of the asset approach is that it can be simple to calculate and understand. Asset valuation is roughly the reproduction cost of the framework or foundation of a business with consideration given to the effects of physical, functional, and economic obsolescence factored into the calculation.
The largest hurdle for calculating value with this approach is determining the fair price of an asset. Beyond finding a fair price, a buyer must determine how the acquisition of these assets would mesh into the plan going forward. The other large concern of this approach is that it completely ignores the earnings potential of the business. These pros and cons have and will continue to be amplified by COVID-19.
Determining Fair Market Value
Determining fair market value of an asset or liability can be complex in any environment. One must determine if the assets are of the quality claimed by the seller and if these assets are facing obsolescence due to changing industry and/or economic conditions. COVID-19 has changed the environment of how businesses operate, and many firms are reconsidering some of their past requirements including office space, technological needs, operational equipment, etc.
For example, if the valuator is using the asset approach to determine the value of a company’s entire supply of laptops, consideration must be given to the technical specifications of the computers such as the audio and visual components as well as the processing speeds.
It’s known that many companies/firms have allowed or required employees to work from home and therefore these attributes are highly important in such scenarios. Similarly, if the valuator is assigning value to furniture such as office chairs, cubicles, etc., consideration must be given to the potential surplus in the market of these assets as many companies may be reducing their physical footprint as more employees are working from home.
Supply Chains and COVID-19
COVID-19 has also put stress on supply chains. Valuators must consider that the market may now be placing more weight on a company’s inventory, if that inventory is currently hard to find.
Conversely, valuators must consider inventory spoilage, if the company was forced to shut down or was unable to get raw materials to complete production. Overall, valuators will need to perform more due diligence on the assets of a company, including inventory, in order to ensure the value assigned is reasonable given the context of the current market conditions and determine if the useful lives of such assets are appropriate and accurate.
While there are some drawbacks to the asset approach, one benefit in the COVID-19 landscape is that it can be used in situations where significant uncertainly exists with the company’s future performance. Uncertainty makes an income approach or market approach less reliable as it necessitates more valuator judgement and the potential for adjustments and projections.
Valuing Business that are Declining
So far, we have referred to an asset approach with an operational business with no pressure to buy or sell which gives us fair market value – in continued use. This means that there is no discount or adjustment to the value of the assets related to the business failing or not generating enough cash flows to cover operating expenses. However, the asset approach is uniquely apt at valuing businesses that are going under.
Valuing a business that is compelled to sell within a reduced period of time is called orderly liquidation value. Under these pretenses, a valuator takes the assets on an “as-is”, “where-is” basis and discounts the value to assist in selling said assets within a short period of time.
Similar to the orderly liquidation value discussed previously, there is also a forced liquidation value which requires a company to sell its assets immediately, which could result in a large discount applied to those assets. With a multitude of companies no longer able to operate or deciding to close up shop because of the negative outlook, we may see this valuation approach used more often.
The Asset Approach Overall
COVID-19 has changed operations for many businesses and the climate of their respective markets. Factors to evaluate going-concern will be more stringent and a business must have disaster planning as a priority. Competitors must be ready and willing to make the best of any turmoil in the aftermath of COVID-19 and a strategy to operate in a multitude of forecasted scenarios.
Valuators will need to practice increased due diligence on a business’ underlying assets to ensure that the assigned values are reasonable in the current economic climate and market conditions. While the asset approach lacks consideration for the cash flows of a business, COVID-19 has proven many businesses will not weather an upheaval of this magnitude and will be forced to liquidate and therefore valued using this approach.
About the Author
Joseph Evenson is a staff accountant on the Valuation and Healthcare Strategy Group and a key contributor in providing healthcare practice management services, specifically focusing on business valuations for physician practices, hospitals and other healthcare related entities.
Contact Blue Today
If you’d like to learn more about business valuation in a post-COVID-19 world, reach out to your local Blue & Co. Advisor or a member of the Business Valuation team below.
Joseph Evenson, CPA, Staff Accountant
Dustin Brown, ASA-MTS, CVA, Manager
Alex Fritz, Director