The Importance of Asset Valuation
In business, an asset is an intangible asset owned by an entity or a company. It is any asset that is owned or controlled by an entity and which can create positive cash flow for an entity and make a positive value for its owner. Many of the assets and liabilities in a business are classified as either tangible or intangible and assets include tangible items such as inventory, machinery, inventories, and licenses or rights to products sold to the business by customers.
Intangible assets include patents, copyrights, trademarks, and trade secrets. The value of intangible assets is determined by their worth and the price will change over time depending on their worth, the condition of the asset, and the owner’s needs. While intangible assets do not have a direct bearing on a business’ cash flow, they can create a significant amount of value for a business if they are properly valued and maintained. A company’s ability to retain and develop its own assets, as well as to sell or lease existing assets, will have a significant impact on the company’s overall cash flow.
The concept of intangible assets and cash flow is most useful when used in the analysis of the income statement and balance sheet of a business. When used correctly, it can provide a strong foundation for an evaluation of the firm’s ability to generate additional cash flow from existing assets and/or to incur new assets that will add to its cash flow.
Some asset categories, including fixed assets, include specific quantities and values that need to be determined in order to determine the value of the firm. Fixed assets are those assets that are immovable, or that cannot be changed without the consent of the owner. Some types of assets include property (e.g., real estate, land, equipment, building), inventory, inventories, and vehicles. Fixed assets generally create value during their initial purchase and depreciate as they are used by the firm.
Other categories of assets include variable and flexible assets. Variable assets include those that can increase or decrease in value based on a firm’s performance and growth. They can vary greatly depending on the economy and can create substantial fluctuations in the value of the firm, sometimes requiring careful timing to gain the maximum return on investment.
Flexible assets include assets that are not fixed or immovable and therefore can be easily moved to accommodate changes in the firm’s current or future situation. Examples of flexible assets include stock options, stock investments, and real estate.
The difference between tangible and intangible assets can make the classification of a firm’s assets and cash flow difficult. However, if an organization properly categorizes and accounts for the assets it holds, then an accurate comparison between its current value with its future cash flow can be made. One way to determine the value of an asset or the worth of an asset can be done by assigning a value to it based on the market value at the date of purchase, the expected cash flows of that asset over time, and the expected life of the asset.
The value of an asset can be calculated by multiplying its present cash flows against the rate of interest it will earn over its expected life-cycle and dividing by the value of the capital stock. This value can then be compared to the value of the capital stock to determine a firm’s current worth.
When an organization is considering making a purchase of assets, its cash flow should also be considered. If the purchase is not a sound financial decision, the purchases will likely result in substantial losses to the company, even though they may appear profitable at the time of purchase. A good cash flow analysis will allow management to evaluate a firm’s current value and profitability on a monthly basis.
Cash flow analysis can also be used to identify the value of an asset. For example, if an organization owns a small plant and has a very low starting value, a good value analysis would identify the plant’s future potential in relation to the firm’s future production, determine the amount of additional equipment needed to meet its needs, and the price per unit of that equipment, and then compare that value with current market prices.
Value analysis is a critical tool when purchasing or selling any asset or business. Asset valuation is an important element of any business analysis, whether it be the acquisition operation, maintenance or disposal of the firm. It is the basis for a firm to determine the value of an asset. Whether it is purchasing a manufacturing plant, a real estate or a commercial real estate office, or acquiring a portfolio of assets to make up for declining sales, determining the worth of assets and cash flow is essential to a firm’s success.
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