Net Assets Method of Valuation of Share

Net Asset Method, also known as the Asset Backing Method or Intrinsic Value Method, is a method of valuation of shares based on the net worth of a company. Under this method, the value of shares is determined by considering the fair value of total assets and deducting all external liabilities. The balance represents the net assets available to shareholders. The value per share is calculated by dividing net assets by the number of shares. This method focuses on the company’s financial strength rather than its earning capacity.

The basic concept of the Net Asset Method is that the value of a share depends on the assets backing it. It assumes that shareholders are entitled to the residual interest in the company’s assets after settling all liabilities. Therefore, a company with strong assets and fewer liabilities will have a higher share value. This method is particularly useful when the company is liquidating, asset-rich, or not earning normal profits.

Applicability of Net Asset Method

The Net Asset Method is commonly used in the following situations:

• Valuation of shares of unquoted companies
• Valuation during liquidation or winding up
• Companies with low or fluctuating profits
• Investment holding or real-estate companies
• Determination of value for merger, takeover, or buy-back

It is less suitable for highly profitable companies where earnings matter more than assets.

Types of Net Asset Method

The Net Asset Method can be classified into two types:

(a) Going Concern Basis

Assets are valued at their fair or replacement value, assuming the business will continue operations.

(b) Liquidation Basis

Assets are valued at their realizable value, considering forced sale or liquidation expenses.

The choice depends on the purpose of valuation.

Steps Involved in Net Asset Method

The valuation under this method involves the following steps:

Step 1. Ascertain the fair value of all assets, including fixed assets, investments, current assets, and intangible assets (excluding goodwill if internally generated).

Step 2. Deduct external liabilities, such as creditors, debentures, loans, and provisions.

Step 3. Determine net assets available to shareholders.

Step 4. Allocate net assets between preference shareholders and equity shareholders.

Step 5. Divide the net assets available to equity shareholders by the number of equity shares to obtain the value per share.

Treatment of Assets and Liabilities

• Fixed Assets are taken at fair or market value.
• Current Assets are taken at realizable value.
• Fictitious Assets like preliminary expenses are excluded.
• Goodwill is included only if purchased.
• Contingent Liabilities are usually ignored unless likely to occur.
• Preference Share Capital is treated as a liability while valuing equity shares.

Formula for Valuation

Value per Equity Share = Net Assets available to Equity Shareholders / Number of Equity Shares

Where,

Net Assets = Total Assets – External Liabilities

Advantages of Net Asset Method

• Simple and easy to understand
• Useful for asset-based companies
• Suitable during liquidation
• Reflects financial stability
• Less affected by profit fluctuations

Limitations of Net Asset Method

• Ignores earning capacity
• Valuation of assets may be subjective
• Not suitable for service-based companies
• Does not consider future prospects
• May undervalue profitable companies