Earnings methods assume the trade continues and that someone will pay for the cash it throws off. Asset methods become the primary language when that assumption is weak, disputed, or simply not the decision. A property company. A holding company whose only real asset is a subsidiary’s shares. A workshop that has lost its main customer. A dispute in which one side claims the business is “just the building”. And, more quietly, the floor underneath every earnings valuation, so that a pretty multiple cannot float free of the things a bailiff could identify.
Book value is an accounting history
The net assets figure in a set of UK SME accounts is not a valuation. Under FRS 102, property, plant and equipment is often still at depreciated historic cost. A workshop bought twenty years ago in Wadebridge or anywhere else may sit on the balance sheet at a number that amuses the bank and insults the surveyor. Inventory may be carried at cost when some of it is slow. Receivables may include a balance everyone in the office knows is hopeful. Goodwill purchased in an old acquisition may still be there, while the goodwill of the company’s own reputation is not on the page at all, because internally generated goodwill is not recognised.
So the first dialect, pure book value, is useful as a reconciliation to the accounts and almost useless as a price. You still start there, because any fair-value bridge that cannot get back to the signed accounts is a story without a spine.
Porth’s balance sheet, book and fair
The same fictional fabricator as the other essays. Figures in pounds.
| Item | Book £ | Fair, going concern £ |
|---|---|---|
| Freehold workshop | 410,000 | 780,000 |
| Plant and machinery | 260,000 | 190,000 |
| Inventory | 310,000 | 275,000 |
| Receivables | 420,000 | 400,000 |
| Cash | 90,000 | 90,000 |
| Total assets | 1,490,000 | 1,735,000 |
| Trade payables | 280,000 | 280,000 |
| Bank loan | 710,000 | 710,000 |
| Net assets | 500,000 | 745,000 |
Check the additions. Book assets 410 + 260 + 310 + 420 + 90 equal 1,490. Fair assets 780 + 190 + 275 + 400 + 90 equal 1,735. Liabilities are 280 + 710, which is 990, on both columns, because this illustration does not reopen the loan or the supplier ledger. Book net assets are 1,490 minus 990, which is 500. Fair net assets are 1,735 minus 990, which is 745.
The movements are ordinary and worth saying in words. The freehold is worth more than depreciated cost; that uplift is a surveyor’s judgement in a real file, not a director’s hopeful note. The plant is worth less than book, because a specialist machine in a thin second-hand market does not fetch its accounting net book value. Inventory is haircut for slow lines. Receivables lose a specific doubtful balance. Cash is cash.
Going concern is not break-up
The fair column above assumes the workshop keeps being a workshop. The machines are valued in place, the inventory is valued as stock a continuing business can sell at a normal margin over time, and the receivables are collected in the ordinary course. That is a going-concern net asset value. It is still an asset method. It does not include the value of customer relationships, the workforce, or the order book, except insofar as those things are already sitting in receivables.
Break-up, or orderly realisation, is harsher. Auction the plant and you may get less than the 190,000 in-place figure. Clear the inventory in a hurry and the haircut deepens. Pay redundancy, agent’s fees, and a period of empty rates on the freehold. The loan becomes due. A break-up column is not produced in this essay because inventing a second full fire-sale without a reason would only look precise. The discipline is to label the dialect. If a shareholder says “the assets are worth 745,000”, ask: in place, or on the lorry?
The gap that earnings methods are really about
The discounted cash flow equity value in the first essay is 3,946,337. The fair going-concern net assets are 745,000. The difference, 3,201,337, is the residual. People call it goodwill. It is the present value of earning a return above the return already implied by owning these assets outright. If that residual is large, the argument is about earnings quality, not about the building. If a negotiation suddenly treats Porth as “only the yard”, someone is trying to buy the residual for nothing.
The reverse is just as important. If an earnings method produces an equity value below fair net assets, the forecast is saying the assets are trapped in a trade that does not earn their keep. The rational owner then asks whether the property should be sold, let, or kept. That question is a strategy question wearing a valuation coat. Asset value has done its job when it forces the question into the room.
UK reporting habits that tangle the work
- Revaluation of property is optional under FRS 102. Two identical workshops can show wildly different book values because one director revalued and one did not. Always ask the date and the basis.
- Investment property, where the company holds a building to earn rent rather than to make the product, is a different line of thinking from an owner-occupied workshop. Do not run a trading multiple across a company that is mostly a landlord.
- Internally generated brands, customer lists and know-how stay off the balance sheet. Their absence is not evidence they are worthless, and their sudden appearance in a director’s “valuation” spreadsheet is not evidence they are worth the number typed next to them.
- A subsidiary held at cost in a parent company’s individual accounts tells you almost nothing about the group. Asset value at the parent, and earnings value at the trading company, have to be drawn on the same map.
- Deferred tax on a property uplift is easy to forget. If the fair value could not be realised without tax, a buyer who cannot roll the gain over will price the tax. This classroom column ignores that, and says so.
When this method should lead
Lead with assets when the business is not a going concern, when the earnings are so erratic that a multiple would be a costume, when the company is a pile of investments, or when the decision is a secured lending conversation in which the downside is the recovery. Keep assets in the file even when earnings lead. The worked cases show Porth’s three equity figures on one page: cash flow 3,946,337, precedents 3,844,000, comparables 3,469,600, and the asset floor at 745,000. The floor is not a fourth vote in an average. It is the number you land on if the other three stories fail.