For all of us who are pursuing our dreams, creation of 'value' is one of the most important objectives. The concept of 'money' is based on the idea of valuing the worth of assets and products. Ergo, 'Valuation' is one of the most important and core concepts in accounting. This necessitates that every student of economics has a good grasp of how valuation of assets is accomplished and why it's necessary.
About Asset Valuation
In financial terminology, an asset is any tangible or intangible entity which has monetary value, or has the future potential to create monetary value. The net worth of any individual or a business is the sum total of the valuation of each asset owned, minus the liabilities. Every asset needs a valuation system, that is custom-made to its nature, the way in which it translates into liquid assets and the variables which influence its value. Therefore, there are various asset valuation techniques, ranging from absolute value models (based on the expected future cash flow generated by the asset), relative models (based on pricing of similar assets) and options pricing models (used for valuing market securities).
There are many more models, each created to provide the best possible valuation of the asset under consideration. The asset may be an entire business, real estate, stocks, trademarks, copyrights, cash and cash equivalents, inventory, securities, antiques, receivables and many more such cash generating entities. After this brief overview, let us see how asset valuation is useful.
Why is Asset Valuation Necessary?
Why do accountants go through the exercise of crunching tons of numbers to compute the value of assets? Here are reasons why all that effort is necessary.
To Ensure the Right Price is Paid
When a business or any individual is considering investment in a particular asset, its valuation is necessary to ensure that the right price is paid. That is the most fundamental reason why asset valuation is an important activity in accounting.
Taxation is one of the primary reasons why valuation of assets becomes an essential exercise. There is property and income tax to be paid, which requires the valuation of real estate property, as well as other assets. This makes accurate calculation of tax dues possible.
To Analyze Investment Potential
If you are investing in a real estate scheme, a business or any other entity, with the purpose of asset creation, it's imperative that valuation of the entity be undertaken. It helps you in gauging the future earning potential of the asset.
For Financial Reports and Audits
For public listed companies or businesses that fall in regulated sectors, it's mandatory that they provide financial reports and subject themselves to financial audit. This reporting and expected transparency from businesses necessitates that asset valuation be carried out. Investors can then decide the worth of a company, from the valuation of its assets.
For Mergers and Acquisitions
When two companies are thinking of merging together or an acquisition is being planned, asset valuation is absolutely essential. This helps the people involved know the worth of any company involved in such a financial takeover or merger. It helps in 'sizing up' a business.
When a business or any individual applies for a big loan, banks demand collateral. Whatever assets pledged as collateral, need to be valued. It forms an important detail, as the bank grants a loan, against the value of the security you offer.
Capital budgeting is the complete analysis and planning of the investments made in a business. The value of each tangible, as well as intangible asset of the company needs to be evaluated, in order for the planning process to make sense and create a realistic forecast of future developments.
So these were the prime reasons why asset valuation is a necessary exercise for any individual or business enterprise. Be it mergers, acquisitions or investments, knowing the value of assets in any of the above situations, enables people to arrive at an informed decision about the matter at hand. If value is to be turned into wealth, asset valuation is an inevitable exercise!