This question is topical in the context of Business Valuations and should not be confused with the physical assets that a business owns.
The answer, strangely enough, lies in the Income Statement or Cash Flow Statement of the business and not the Balance Sheet!
Price determining factors in a business valuation
As the most dominant price determining factor is, and always will be the ratio between the price and the returns the owner earns from his business (P: E ratio) it is important to start analysing from this point. There are obviously other factors such as the scalability, sustainability and lifestyle factors combined with risk and perceived risk… but the most dominant price determining factor remains the ratio between the earnings and the price.
I have regularly carried out business valuations in the past year or two where businesses no longer make a profit. When the earnings of a business has disappeared and the price needs to be established as a factor of this earnings the result is always going to be zero- or a negative price in fact. Other methods such as the net discounted cash flows would also dictate a zero or negative price. In such a case it becomes a whole lot more difficult to sell and the focus turn to the Net Asset Value (NAV) which forms part of such a transaction.
In a recent valuation the business has produced sustained losses of over R3,0m per annum but the business still had a Net Asset Value in excess of R40m but this was dwindling fast as a result of ongoing losses. The seller was however very upset and disappointed to learn that a buyer may actually only pay 30c – 50c in the Rand for the NAV. The buyer physically have to be incentivised to buy the Assets of the business by selling it at a discount of its market value.
GOODWILL can be defined as the amount that a buyer is prepared to pay MORE than the NAV at market price. When the price offered is however less than the NAV we generally refer to it as ILLWILL. It is in fact in such a case where a business and its activity cannot be seen as an asset, but a liability.
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