One of the key assumptions made for any business appraisal is the premise of value. Depending on the circumstances surrounding business valuation the results may differ greatly.
By far the most common assumption for valuing a business is that it will continue operating in the foreseeable future as a going concern.
However, there are situations when other premises of value apply. When a valuable asset is bought, the owner is likely to ensure it. Insurances companies are concerned with total loss of the asset. The insurable value is thus the cost of reproducing the lost asset.
On the other hand, a lender that considers the business asset as a collateral is more likely to value it on the liquidation basis. The worst case scenario for the lender is the possibility of having to dispose of the asset at an auction. The price fetched in these circumstances is likely to be considerably lower than the fair market value. In addition, the lender incurs additional costs associated with the sale.
Small wonder that the replacement cost value and liquidation value are usually far apart. This makes sense because the circumstances of valuing the business asset are so different here.
If a business asset is lost in needs to be replaced. So the cost of acquiring a new asset dictates its value. On the other hand, a lender is probably not interested in using the business asset nor in incurring the maintenance and marketing costs to get the highest price possible. A forced sale under the auctioneer’s hammer is likely to fetch a lower price.
On a value continuum, the replacement cost and liquidation values are at the opposite ends of the value range. Somewhere in the middle is the fair market value that indicates what the business asset is worth in use. In business appraisals, this value is determined as the replacement cost less the depreciation due to use, aging and obsolescence.