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Out of the hundreds of quotes that Warren Buffet has used to share his wisdom over the years, this one is my favourite:
“There are only three types of people in this world, those that can count and those that can’t.”
However, there really are only two types of value in a company, the value of the tangible assets, and the value of the intangible assets. The fair market value of a company is the sum of these two types of assets. While this may seem obvious, the twist is that the value of the intangible assets is often not calculated directly. Rather, the value of intangible assets (A) is generally determined by subtracting the value of the tangible assets (B) from the fair market value (C). That is to say, C – B = A, not A + B = C.
In the process of determining the fair market value of an operating company, a Chartered Business Valuator (“CBV”) will consider the expected future operations, normally through a review of the historical income statements and / or operational forecasts. However, when determining the value of the tangible assets, the CBV will look to the balance sheet as at the effective date of the valuation (“the Valuation Date”). Here, the CBV is looking to determine the net tangible asset value (“NTAV”) of the company. This is the fair market value of the net tangible assets that are required in order to generate the expected future operating cash flows, which in turn is what drives the fair market value of the Company.
In calculating the NTAV, the CBV will typically consider two types of adjustments and, depending upon the methodology employed, may consider a third. These adjustments are as follows:
In part 1 of this 3-part series, we will examine the first step.
The CBV will normally consider if the reported net book value of any of the items on the balance sheet of the company as at the Valuation Date is significantly different from their fair market value.
This step is required since, under Canadian generally accepted accounting principles("GAAP"), financial statements are presented on a historical cost basis. This means that the land that a company bought ten years ago for $10,000 is still on the balance sheet for that amount today, even though it might be worth $500,000. So, the CBV would adjust the net book value of that land from $10,000 to a fair market value of $500,000.
Obviously, this adjustment would positively impact the value of the company.
In order to obtain clarification of these topics, please feel free to contact myself or your local MNP advisor.
The next step in determining NTAV is to examine whether or not there exist any redundant assets in the company.
More From This Series:
Part 2 - Redundant Assets
Part 3 - The Value of Leverage
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