Mariusz Chudzicki

Czestochowa University of Technology

 

Asset valuation value of the company

 

Abstract: The problem of valuating companies and their assets is very complex. It is the effect of high level of diversity, uniqueness of the valuation subject, which is a company, and also of the ambiguity of "value" term. The same valuation subject may represent different values, according to the performer, basis and purpose of the valuation. The most common approaches in the evolution of company valuation methods include asset and income approaches. The purpose of this paper is to show the usefulness of asset methods for company valuations. The "quality" criterion adopted was the market valuation, which is commonly perceived as the most accurate valuation method.

 

Keywords: valuation, market value, book value, Wilcox model

Introduction

The valuation is usually defined as a set of given rules: calculation procedures subordinated to purposes, analysis and estimations, that allow to determine the value of a complex entity – a company – for the specific moment in time, specific place and specific economic-social conditions. The problem of valuating companies and their assets is very complex. It is the effect of high level of diversity, uniqueness of the valuation subject, which is a company, and also of the ambiguity of "value" term. The same valuation subject may represent different values, according to the performer, basis and purpose of the valuation.

The process of company valuation relates to many different elements, that includes the following[1]:

-        moment of valuation representing the time relativity of value category,

-        purpose of valuation and the character of parties interested in its results,

-        character of measurement basis in the valuation – both value measurement in static approach (assets, capital) and dynamic (income) and adopted measures of future streams (the price system included in the projection),

-        valuation methods serving as a tool for value measurement,

-        possible variants of the measurement and including them in the decision process.

The selection of methods or the method used for company valuation should be based on the purpose criterion, relating to the valuation. In some countries the selection of methods for valuation made for particular purpose is determined by legal requirements. It is the case for valuation undertaken to assess the assets value tax, stamp duty and insurance premium, or when it used for the company's balance sheet. In practice the selection of the method is also affected by its off-taker. The off-taker can be the company management, its personnel, State Treasury, insurance or tax institutions, or any other entity willing to order a valuation.

The supplement for the economic-financial view for the company is the technical-organizational approach, which identifies the condition of company's success – rationality and efficiency of its activity – as the proper correlation and organization of different forms of production factors. Those factors comprise for a dynamic whole, which affects the success of the company, and in result its positive evaluation according to adopted criteria[2].

The functional approach to valuation process, allowing that it can serve different purposes and fulfill expectations of different parties, enables to make this process more objective, and helps to achieve final effects, that satisfy all interested parties. The realization of valuation function purposes is achieved through the specific valuation procedure, which construction depends on the character and substance of value category of the company.

Each valuation should lead to determine the real value of evaluated assets and the company as a whole. This is the general purpose. But the detailed purposes can differ.

Once again it justifies the need to introduce the versatile measurement of company value, based on different criteria, using a variety of methods, and further analysis and evaluation of obtained results of the valuation. While choosing the methods and deciding for specific way of valuating assets and company it is important to bear in mind:

-          purpose, which the valuation results are about to serve,

-          number and nature of assets being valuated,

-          scale and diversity of assets being valuated,

-          scale and diversity of range and subject of economic activity of the company being valuated,

-          disposition of assets and company being valuated,

-          character and quality of information (on valuation subject) obtained and possible to obtain.

These factors determine the selection of valuation method, its range and subject, procedure, but also affect the accuracy and credibility of the results. It is difficult to estimate the company value using a single method. Thus it is recommended to employ various methods.

The most important trends in the evolution of company valuation methods include asset and income approaches. Asset approach include market estimation of the value of all assets of the company and related rights. Income approach include the determination of the company's ability to produce incomes (benefits and profits), that depend on the combination of managerial skills, use of available resources and other resources. At present the company valuation methods are usually divided into four groups:

-          asset methods,

-          income methods,

-          comparison (factor) methods,

-       mixed methods.

This paper discuss the asset methods.

Company valuation using asset methods

Asset methods are the oldest approach to valuation of economic entities. Company value, determined using those methods is called asset value. Company value in this approach is based on the balance sheet, with no allowance for future development, condition of the economy, internal problems, thus all the factors, that are not included in financial statements. Methods in this group include:

-          book value method,

-          modified book value method,

-          net asset value method,

-          modified net asset value method,

-          liquidity value method,

-          replacement value method.

Company valuation according to its book value is the simplest valuation method. It only requires the valuator to read from the company's liabilities side of the balance sheet the value of its own capital, which consists of:

I. Share capital

II. Called up share capital not paid (negative value)

III. Own shares (negative value)

IV. Supplementary capital

V. Revaluation capital

VI. Other reserve capital

VII. Retained profit (loss)

VIII. Net profit (loss)

IX. Net profit write-offs during the financial year (negative value)

Modified book value method is based on the idea to modify present book value with projected profits or losses, which the company should produce in the future, and with the value of off-balance sheet assets[3]. The problem here is how long the projection period should be and what is its credibility.

Net asset value method is the most common asset method and enables to obtain information on company assets value relatively quickly and simply. It is based on data from company's balance sheet, thus the results produced by this method origin from valid rules of balance sheet valuation of assets and liabilities of the company. This last element effects in some reasons, for which the method does not always reflect the real value of net assets of the company in the moment of valuation. Those reasons include[4]:

-            unreality of the book value of fixed assets caused by the simplified rules of revaluation (regardless of the adopted method), allowing for the price changes due to inflation,

-            simplified rules of depreciation, which result in unpropriate reflection of the assets depreciation,

-            adopted rules of writing off low value fixed assets, and also the elements of equipment,

-            valid rules of long-term and short-term securities valuation.

Above factors cause that the results based on net asset value can not be and are not considered credible enough[5].

Net asset value is usually defined as the balance sheet total reduced by the value of the company's liabilities. The book value of the company (own capital value) and its net asset value are often treated as one. Yet these two values are identical only when the balance sheet does not include such elements as reserves and accrued costs/expenses.

Modified net asset value method is a variation of the above method. According to its name it is based on the overall assumptions of net asset value method, but the initial book value is modified due to market (and not book) value of specific assets and capitals of the company being valuated. The range and nature of these modifications is directly dependant on the purpose of the valuation and its procedure formalization level. The application of modified net asset value method should include several stages:

-          Obtaining the balance sheet of the company being valuated for the moment of the valuation or the day closest to that moment.

-          Making the necessary modifications relating to known, but not included in the balance sheet assets and liabilities, or to updates of the balance sheet data for the moment of the valuation.

-          Modifying the value of all tangible assets and identifiable intangible assets to their market values.

-          Modifying the value of liabilities to their market values, if they differ from the book values.

-          Making the necessary modifications relating to tax liabilities and interest on debt.

The result obtained this way should be closer to the real value, as figures from company's balance sheet, especially on assets side do not reflect the real value of company's assets. The deviation can be both positive and negative, and is often a result of neglecting the integrity rule in bookkeeping.

Liquidity value method, the fifth of methods listed above, identifies the value of the company in the moment of sale of its specific assets as a sum of possible net income (and thus is sometimes treated as the modified net asset value method). Such valuation is also helpful in case of companies that are about to continue their activity, as it determines the floor value, that would satisfy the owner in the case of negotiating its sale. Liquidity value can be also defined as the minimum value of the company, as it does not make an allowance to further possibility to continue its activity[6]. Using this method to valuate the company consists in determining the income from the sale of individual assets of the company. The total assets sale income should be reduced by the financial liabilities, that would arrive in the case of liquidation. The result represents the liquidity value of the company.

During the determination of income from the sale of individual assets of the company each asset should be valuated separately. However it can be very expensive and time consuming or just impossible. In such cases it is acceptable to employ methods simplifying the valuation. The most popular model is the Wilcox model, according to which the liquidity value of the company equals[7]:

 

= value of cash

+ value of securities

+ 70% of receivables

+ 50% of book value of other assets

– total liabilities

 

The Wilcox model has, among others, the advantage of simplicity, but it is important to bear in mind the character of the activity of the company being valuated, as it affects the quality of assets, e.g. modifying receivables with bank guarantees is overcautious, just as with stock with high liquidity (fuel, jewelry).

The purpose of the replacement value method is to estimate the amount of financial expenditures needed to replace the individual assets of the company being valuated. This method is often used by investors facing the decision whether to buy a company or start a completely new one. The disadvantage of this method is the difficulty in estimating such elements as the goodwill, and the time needed to achieve given position on the market, which substantially determine the cost of the company replacement. It can be stated, that replacement value method is practically only suitable in case of small companies that have small share in the market, which activity is easy to duplicate. The replacement value method is also called the present replacement cost method or the reproduction method. There are several sources of data used to determine the replacement value. The most important are considered the following:

-          up-to-date prices catalogues,

-          replacement cost of own products,

-          authorized price indexes for individual types of economic resources,

-          sector price indexes[8].

Market valuation

The common perception is that the market valuation is the most accurate method of company value determination. Of course it relates to the limited number of companies listed on the stock exchanges. However the number of companies listed on both markets of Warsaw Stock Exchange constantly increases. Moreover the new market NewConnect, designed for smaller, dynamically growing companies, starts to valuate greater number of entities. The value of the company here is the product of number of issued shares and current market price, and equals the company market capitalization.

Such valuation faces some problems as well. The market price does not need to represent the real value of the company. The company shares can follow the overall rise or fall trend on the market. Market prices of shares of small companies with low liquidity may follow the speculative decisions[9].

Tables 1 and 2 illustrate the comparison between the valuation using two asset methods (the book value method and Wilcox liquidity method) and the market valuation for two time ranges based on the quotations from the Warsaw Stock Exchange primary market. The selection of companies for the analysis is random. They include entities representing the largest companies of WIG-20 (KGHM and PKN Orlen), and also medium-sized companies of mWIG-40 (Netia) and sWIG-80 (Lentex). Alchemia company is not included in indexes due to the small amount of listed shares.

In the first analyzed period almost all companies had the market valuation much higher than the book and liquidation values. The exception here is the book value of PKN Orlen close to its market value and also of Netia, which is much higher then its market value. It may prove the undervaluation of the company or the low confidence of shareholders. The total market value significantly exceeds the book value and the liquidation value resulting from Wilcox model.

Results more close to market value can be observed in Table 2, where the total market value is similar to the book value. In comparison to former research the value of companies dropped dramatically, what was caused by the price reduction on stock exchanges not only in Poland but also on foreign markets[10].

 

Table 1. Market value of selected companies and their value determined with asset methods

Company

Price on

02.01.2008

Market value

(million PLN)

Book value

(million PLN)

Value according to Wilcox model

Alchemia

11,25

2 508,6  

588,6  

303,1  

KGHM

104

20 800,0  

9 501,6  

8 151,2  

Lentex

33

359,4  

191,0  

92,6  

Netia

3,9

1 518,2  

2 020,2  

1 033,9  

PKN ORLEN

52

22 240,9  

22 619,4  

1 777,5  

Total

47 427,1

34 920,8

11 358,2

Source: Companies and www.gpw.pl

 

Table 2. Market value of selected companies and their value determined with asset methods (second research)

Company

Price on

18.07.2008

Market value

(million PLN)

Book value

(million PLN)

Value according to Wilcox model

Alchemia

7,1

1 583,2  

588,6  

303,1  

KGHM

83,65

16 730,0  

9 501,6  

8 151,2  

Lentex

14,77

160,9  

191,0  

92,6  

Netia

3

1 167,8  

2 020,2  

1 033,9  

PKN ORLEN

36

15 397,5  

22 619,4  

1 777,5  

Total

 

35 039,4  

34 920,8  

11 358,2  

Source: Companies and www.gpw.pl

 

Asset methods, especially analyzed here book value method and liquidity value method using Wilcox model, give results different from market valuation. It can be stated that during the slump the market value draws near the book value, and the Wilcox model is practically useless in Polish conditions, regardless of the condition of the stock market. In spite of relatively small time and space range of the research, such great deviations can not be accidental. It suggests the need to modify the Wilcox model to Polish conditions.

Conclusions

The company valuation in asset approach should become the integral element of every valuation – regardless of being conducted using methods requiring the evaluation of company's assets or not. The company value resulting from asset approach can be widely and diversely used for the company valuation. It has various functions, such as:

-          it is a criterion for valuation in mixed approach,

-          it constitutes the comparative value for the company value based on its future income,

-          it is a base for estimating the depreciation write-offs for the purpose of future cash flows projections,

-          it determines the value of capital invested by the owners,

-          defines the possible investment needs of the company.

It has to be noted that asset methods, despite being imperfect tool for company valuation, in some cases can be the only possible criterion in that valuation. It is especially the case when:

-          it is difficult to project the company income – which may be caused by constant losses produced this company or the lack of data needed for the projection,

-          the company is not subject to depreciation due to its activity character,

-          it is impossible to select the similar sector to constitute a base for a comparison valuation with factor methods.

However it should be noticed that at present the value of well managed company is largely dependant on such intangible factors as goodwill, position on the market (usually demonstrated by the share in the market), personnel competence (intellectual capital) and most of all the company ability to produce positive cash flows. The negligence of those factors is the main disadvantage of asset methods. It is proved with above study.

Bibliography

1.        Borowiecki R., Jaki A., Kaczmarek J., Metody i procedury wyceny przedsiębiorstw i ich majątku, Wydawnictwo Profesjonalnej Szkoły Biznesu, Kraków 1998.

2.        Borowiecki R., Efektywność gospodarowania środkami trwałymi w przedsiębiorstwie, PWN, Warszawa – Kraków 1988.

3.        Grudzewski W. (ed.), Wycena firmy dla potrzeb tworzenia spółek kapitałowych, ORGMASZ, Warszawa 1990.

4.        Kufel M., Metody wyceny przedsiębiorstw, Wydawnictwo Park, Bielsko – Biała 1992.

5.        Lee T.A., Inkom and Value Measurement, Van Nostrand Reinhold (UK) Co Ltd, Berkshire 1987.

6.        Machała R., Zarządzanie finansami i wycena firmy. Unimex, Warszawa 2008.

7.        Machała R., Praktyczne zarządzanie finansami firmy, PWN, Warszawa 2001.

8.        Melich M., Nowoczesne metody wyceny przedsiębiorstw [w:] Wycena i zarządzanie wartością firmy, pod red. Szablewskiego A. i Tuzimka R., Poltext, Warszawa 2007.

9.        Pasieczny L. (ed.), Metody i procedury wyceny przedsiębiorstw, TOPEXIM, Warszawa 1991.

10.     Siegel J., Shim J., Hrtman W., Przewodnik po finansach, PWN, Warszawa 2001.

11.     Kamela – Sowińska A., Wartość firmy, PWE, Warszawa 1996.

12.     Kamela-Sowińska A., Wycena przedsiębiorstw i ich mienia w warunkach inflacji, Fundacja Rozwoju Rachunkowości w Polsce, Warszawa 1994.

13.     www.gpw.pl.

 


[1] Lee T.A., Inkom and Value Measurement, Van Nostrand Reinhold (UK) Co Ltd, Berkshire 1987, p. 20 and Kufel M., Metody wyceny przedsiębiorstw, Wydawnictwo Park, Bielsko – Biała 1992, pp. 121-150.

[2] Kamela-Sowińska A., Wycena przedsiębiorstw i ich mienia w warunkach inflacji, Fundacja Rozwoju Rachunkowości w Polsce, Warszawa 1994, pp. 25-26.

[3] See Machała R., Zarządzanie finansami i wycena firmy. Unimex, Warszawa 2008.

[4] Borowiecki R., Efektywność gospodarowania środkami trwałymi w przedsiębiorstwie, PWN, Warszawa – Kraków 1988, pp. 12-17, Wycena firmy dla potrzeb tworzenia spółek kapitałowych, Grudzewski W. (ed.), ORGMASZ, Warszawa 1990, p. 98, and Metody i procedury wyceny przedsiębiorstw, Pasieczny L. (ed.), TOPEXIM, Warszawa 1991, pp. 19 – 20.

[5] Borowiecki R., Jaki A., Kaczmarek J., Metody i procedury wyceny przedsiębiorstw i ich majątku, Wydawnictwo Profesjonalnej Szkoły Biznesu, Kraków 1998, p. 45.

[6] See inter alia Melich M., Nowoczesne metody wyceny przedsiębiorstw [in:] Wycena i zarządzanie wartością firmy, pod red. Szablewskiego A. i Tuzimka R., Poltext, Warszawa 2007, p. 144.

[7] Cf. Siegel J., Shim J., Hrtman W., Przewodnik po finansach, PWN, Warszawa 2001, pp. 470–471.

[8] See Kamela – Sowińska A., Wartość firmy, PWE, Warszawa 1996r., p. 170.

[9] See also Machała R., Praktyczne zarządzanie finansami firmy, PWN, Warszawa 2001, pp. 428-429.

[10] WIG 20 index decreased by about 25% during this period.