How the Adjusted Net Asset Method Works

Generally, the adjusted net asset method takes into account tangible assets, intangible assets, off-balance sheet (OBS) assets, unrecorded liabilities (e.g., leases).This financial accounting method is a rather straightforward one but, at the same time, requires detailed analyses to find the right market value that reflects the financial standing of the company. Different ways to carry out this evaluation are:

  • Stock Market Comparison: Here, the company's data is compared with samples from other entities of similar activity, size, risk, growth, etc. Considering past transactions from samples of comparable companies aid in evaluating new transactions.
  • Target price: In this case, the evaluation includes a list of target prices published by company brokers. For non-listed companies, it is important to apply an illiquidity discount for the valuation.
  • Discounted Cash Flow: The working principle here is that the value of an asset is equal to the net present value of future cash flows it generates. Hence, assets are valued based on the expected returns they will create for the company. This cash flow is, of course, discounted for the level of risk associated with it.

With any of these three scenarios, adjustments are made to the value of fixed assets. It factors in unrecorded liabilities and accounts for uncollectable balances by reducing accounts receivable, among other things.

Real World Example of the Adjusted Net Asset Method

NextStage AM prepared an Adjusted Book Value for 2019 with the assistance of an external auditor from Sorgem Evaluation. The three evaluation methods were used by comparing data from the previous year, factoring in target prices, and discounted cash flow.

The evaluator observed multiples of a sample of comparable companies then constructs an average or median multiple to evaluate the transaction in question. Next is the selection of target prices to use for the comparison. Finally, the evaluator constructs assumptions underlying a valuation, including the forecast of growth, investment, long-term profitability, and a discounted rate for future cash flows.

While most valuation methods are based on cash flow models, the Adjusted Net Asset method focuses on the assets and liabilities of the company, as clearly indicated. Regular valuation with this method will indicate the company's growth rate. This, in turn, determines other actions that the management will take, e.g., expansion, economies of scale, downsizing, etc.

Significance of the Adjusted Net Asset Method

Market-based approaches and income-based approaches are the more common methods of business valuation. Nonetheless, there are specific situations in which a company would want to opt for this asset-based approach. They include:

  • The valuation of a capital intensive company
  • The valuation of a holding company
  • Liquidations
  • Valuating a company that's been generating constant losses
  • When cash flow valuation methods show a low value than the Adjusted Net Asset value.

Transforming the book value of assets to their market value is only one aspect of the Adjusted Net Asset Method. The goal is to arrive at an adjusted book value that indicates the true worth of the business. The adjusted book value is the adjusted asset total fair market value - the total fair market value of the adjusted liabilities.