The cost approach to valuing a business: description, essence and examples

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2020-04-17 18:00:20

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In practice, the work of each company analyzed. This may apply The income, cost, comparative approach to business valuation. The need for analysis arises in many different situations. Consider further, how is Business valuation methods the cost approach.

cost approach to business valuation

General information

In the international practice, professionals use three approaches to assessment:

  • Cost;
  • Comparative;
  • Profitable.

Performing analysis on domestic organizations is regulated by industry-FZ, and Federal standards (FSS). Each approach provides its own methods of evaluation.

Features

The Comparative approach includes three methods. In particular, analysis is performed of capital markets, industry factors and transactions. The income approach is based on 2 options. Them is the analysis of capitalization and discounted cash flows. The cost approach is also based on 2 methods: method net asset and liquidation value. They are used almost all the transformations of the organization. The analysis performed at acquisition or production, incorporation of company, takeover, merger and so on.

The Cost approach to valuation of enterprise (business)

This variant of the analysis has one key feature that distinguishes him among others. Business Valuation methods the cost approach is element by element. In the analysis of the property complex is divided into certain components. Each resulting element is investigated, revealed its price. In conclusion, all obtained results are summarized and displays the total value of the company.

 business valuation methods cost approach

Key areas

The Cost approach to valuation of business combines:

  1. Study of the savings assets of the organization.
  2. The Adjusted balance sheet value method or net assets.
  3. The Definition of liquidation prices.
  4. Method of substitution.

These options are combined on one significant symptom. They are based on the determination of cost of each specific type of property at current prices or the costs of establishing a similar company (by way of substitution) and subtracting the amount of all debts of the firm. The analysis uses the single database – balance.

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Purpose

The Cost approach to business valuation, typically used to obtain information necessary for making different management decisions. This is the crux of this analysis. You can explain how is the business valuation cost approach on the example of a company that sold, insured or eliminated. Thus, the sale of the firm market price is calculated by the method of accumulation of assets. Insurance often is determined by replacement cost. At the closing of the enterprise, the liquidation price is calculated.

cost approach to business valuation

Advantages

The Cost approach to business valuation has a number of advantages. The main ones can be considered:

  1. The Possibility of accounting for the impact of economic or industrial factors on price fluctuations.
  2. Using the vast information base. The Cost approach to business valuation And is based on the accounting and financial documents. This, in turn, allows to obtain more valid results.
  3. The Ability to analyze the degree of development of the technology of the firm given the level of depreciation of real estate or equipment.

Disadvantages of the cost approach in business valuation

Meanwhile, along with the advantages there are several negative aspects in the analysis. Specialist, taking them into consideration, may refuse to use a Cost approach in business valuation. The most significant negative aspects of the method include:

  1. Determination of the previous prices.
  2. The Inability to take into account the prevailing current market situation at the time of analysis.
  3. Static.
  4. Inability to consider the risks and prospects of the company.
  5. Lack of communication between current and upcoming results of a particular company.

The disadvantage of the cost approach in business valuation is also its complexity.

profitable cost comparative approach to business valuation

The Net book price

Method of its determination is considered the most simple of all, is included in the Cost approach in business valuation. To establish the net book rates of value of currency deducted all liabilities (short - or long-term). The result is the cash value of equity of the company or its assets. The advantages of this method include:

  1. Use only accurate information about the real assets that are owned by the company. This method eliminates the abstract, which is typical of other ways.
  2. In market conditions, the method has the full database.

This method has some negative traits:

  1. It is Impossible to consider the efficiency of the company andthe prospects of its development.
  2. Not taken Into account the situation on the market in terms of supply and demand for similar companies.

Consider, how does business valuation cost approach with an example. Source of balance sheet data is as follows (in u. E.):

  • OS – 5000;
  • Inventory – 1000;
  • Accounts receivable – thousand 1;
  • Money – 500;
  • Debt – 6 thousand

disadvantages of the cost approach in business valuation

In accordance with the conclusions drawn by the expert, the company's fixed assets are worth 30% more expensive, and stocks of raw materials – 10% cheaper. Accordingly, 20% of the accounts receivable can not be collected. Using the appropriate coefficients, to determine the carrying amount:

1000 x 0,8 + 1000 x 0.9 + 5000 x 1.3 + 500 – 6000 = 2700.

Liquidation price

It is defined only in the case when the company ceasing operations and begins to sell their assets to repay obligations. The calculation of the liquidation value allows to obtain the lowest rate in the price level. It reflects the minimum amount at which you will sell the company.

Method adjusted book prices

He is considered one of the varieties of the cost approach. This method includes the total value of the revision of the balance with the adjustment of the residual asset prices taking into account inflation factors. The analysis is carried out revaluation of assets. At the same time the result is entered in the balance sheet. This allows you to define adjusted clean price, which, in essence, serves as an indicator of equity of the company and its revaluation reserve. the cost approach to valuation of business

Method replacement

He focused exclusively on the analysis of material assets and applies only to capital-intensive companies. The evaluation involves the calculation of the cost of complete replacement funds, while maintaining the current financial profile. The analysis is performed in sequence. First, are evaluated accounting and statistical documents. These include:

  1. Quarterly statements.
  2. The Interim liquidation balance sheet.
  3. Statistical reporting.
  4. Inventory card.

The results of this comprehensive study formed the idea of insufficiency or sufficiency of the assets to repay the debt. It then creates the estate for evaluation. We study separately the most/the minimum working capital or liquid assets. Then formed the aggregate amount of indebtedness of the company and shall be a schedule of repayment.

Insights

The Cost approach, based on the analysis of the company's balance sheet, allows one to obtain objective indicators. According to some experts, it is the most reliable option in today's unstable economic conditions. The meaning of assessment is the most accurate calculation of the market value of the enterprise. Analyzes all of its assets, including tangible, intangible and financial.

The Carrying value of these funds is influenced by market changes and inflation. Accordingly, it does not always coincide with market price. This, in turn, necessitates adjustment of the balance. For this is valuing each asset separately.

After determining the current price of all the company's liabilities was subtracted from reasonable market rate for all property. The result will be a price determined by the cost approach. The calculation of the liquidation rate used in the analysis of firms bankrupt or in the case of the alleged loss of solvency in the short term. This price shows the amount of remaining funds after the implementation of the company repayment of the direct costs and other costs.

the disadvantage of the cost approach in business valuation is

Nuances

Note that when the evaluation of real estate enterprise professionals need to be available:

  1. Construction and technical characteristics for each structure. It is formed in accordance with the data of the registration certificate, which, in turn, issued the BTI. In addition, the characterization must be accompanied by the information Department of capital construction.
  2. Background information. The information must be including the funds needed for repairs, and the costs associated with recovery.

It is also Worth noting that the value of the company, determined using the method of liquidating prices never correspond to the actual amounts. Here it is necessary to refer to paragraph 9 of the FSO. It is said that the residual value of the object which reflects the probable amount for which a possible implementation throughout the period of exposure.


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Alin Trodden - author of the article, editor
"Hi, I'm Alin Trodden. I write texts, read books, and look for impressions. And I'm not bad at telling you about it. I am always happy to participate in interesting projects."

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