The balance sheet — which shows a company’s assets and liabilities — is a logical starting point for valuing certain types of businesses. The cost (or asset) approach specifically focuses on this part of a company’s financial statements. Here’s an overview to help you understand this valuation technique. How does it work? When valuation professionals apply the cost approach, they convert the book values reported on the balance sheet to their respective fair market values. There are three key reasons that book value may not reflect fair market value to a hypothetical buyer or seller: 1. Use of historic cost. Under U.S. Generally Accepted Accounting Principles (GAAP), assets are recorded at historic cost. Over time, historic cost may understate market value for appreciable assets, such as marketable securities...

The cost (or asset-based) approach to valuing a business focuses on the balance sheet. This financial statement reports “book values” for the company’s assets and liabilities. Here’s how the cost approach works and when it might be an appropriate method of valuation.  Book value vs. fair market value Amounts reported on a company’s balance sheet for its assets and liabilities may not reflect their fair market value to a potential buyer or seller. One reason is that, under U.S. Generally Accepted Accounting Principles (GAAP), assets are recorded at historic cost. Over time, historic cost may understate market value for appreciable assets, such as marketable securities and real estate. Additionally, internally generated intangible assets — such as copyrights, patents, brands and goodwill — are excluded from balance sheets prepared...