Using the Costs Based Business Valuation Method
The costs based method of business valuation is often the method used when all other methods are inappropriate or do not have information readily available.
It is based on the concept that if you took away the assets (and therefore needed to replace them) - what would it cost to replace.
The method often has a higher degree of uncertainty in the outcomes and often requires more research than other methods.
Let's walk through this business valuation method.
When To Use This Business Valuation Method
This method should be used as either a cross check business valuation method, or where it is the primary method it should be used when:
Valuing intangible assets where there is no significant cash flow associated with the assets.
Where the business is not commercially viable and significant R&D has been undertaken to develop the assets.
Contracts the infer a future right to cash flows.
License or intellectual property rights.
This method is based on the replacement cost (at market level) of the assets in question. In some cases, such as process equipment the replacement cost can be easily determined from suppliers. In the case of intangible assets such as software, developed technology, online platforms, websites or brand value, this method may be the only way of appropriately valuing these types of assets.
This business valuation method often looks at the current cost to replace an asset rather than the cost that was actually spent. For example, a detailed commercial website may have cost $60,000 to build ten years ago, but can be achieved for less than $10,000 now. So the cost basis of such an asset is the current market value of replacement.
One of our clients had developed readily used commercial software that is in place in thousands of businesses nationally. The owners admitted the software cost more than $250,000 to develop in man-hours and other costs. The same software using current software technology to perform the same functions would cost less than $100,000 (at worst).
Another client had a collection of more than 200 regulatory approvals to sell chemicals for certain uses. The licenses were collected over a 5 year period. The same licenses can now be purchased for $10,000 - $15,000 per license and hence the replacement value was well documented.
This business valuation method often relies on cost estimates and detailed research, and the results can be very subjective when data sources are limited.
The Costs Based Method Business Valuation Formula
In essence the business valuation formula is based on a format of the balance sheet:
Enterprise Value = Reported Assets + Unreported Intangible Assets - Less Cash - Less entity-related liabilities - Unreported Liabilities (contingent and non-contingent).
The unreported intangible assets should be listed individually and correlated with asset valuation estimates based on other market sources. Often this method requires assistance from experts within the relevant intangible asset industry.
We have detailed the items that should be used to adjust the reported assets and liabilities in our Business Valuation Calculation Guide.
Go to Our Business Valuation Calculation Guide
First read the guide under the heading introduction so that you understand when to apply this method and how to determine whether your business is commercially viable.
Go to the Costs Based Method section of the guide and estimate the various adjustments to be applied to the balance sheet.
Fill in the relevant table in the Costs Based Method section of the Guide to calculate the enterprise value of your business
Now return to the main Online Business Valuation Calculation page and and continue through the flow chart.
This valuation process and information is general in nature and is to be used at your own risk and discretion. We take no responsibility for any errors in calculation or judgement that you may make based on our information or advice.
We are not responsible for any commercial loss you may realise as a result of relying on the information or analysis that you complete.