Intangible assets and its methods of Valuation

01-December-2020 by Virtue Ventures


After observing your company's balance sheet, financial statements, and client records, you can have an idea of your company's value. These sheets, lists, and statements only track your tangible assets of your business without calculating the value of your intangible assets.

Every company has some kind of intangible assets, whether they know it or not. So, we would understand the meaning of Intangible assets and its methods of valuation along with its importance in this article going forward.


What are intangible assets?

Tangible assets are any physical assets: equipment, real estate, products, and even customers. These are the things which can truly see and touch.
Intangible assets are non-physical assets that play a role in your company's success. Periodically intangible assets play in your organization's long-term growth. It can be divided into two categories: those with indefinite useful lives, and limited-life intangible assets.
An intangible asset that produces income for a specific time frame. The most common type of restricted life intangible asset is a patent because patents have an agreed-upon term when they're created.


Economic Advantages of Intangible Assets:

> Pricing Premiums (ex. Brand)
> Barriers to entry (ex. Patent)
> Marketing Advantages (ex. Distribution network)
> Competitive Advantages (ex. Brand Name)
> Cost Savings (ex. Right to use a coal mine)


Requirements of the intangible asset valuation:


Below mentioned are the instances in which intangible asset valuation will be required and crucial to assess.

Financial Reporting (Purchase price allocation, etc.)

> Mergers and Acquisitions

> Joint Venture purpose

> Licensing and franchising (e.g. Brands, trademarks, etc.)

> Obtain financing from banks or financial institutions

> Internal management review purposes


Methods of Intangible Assets Valuation:

An article in CFA Institute suggests that intangible assets are “increasingly critical to corporate value, yet current accounting standards make it difficult to capture them in financial statements.”

As investment in intangible assets have grown across the globe “the value of those assets as drivers of enterprise value becomes more essential.”

The following five common methodologies that “built on historical and prospective financial information within the framework of current accounting standards” and explains how they can be used to ascertain a firm’s competitive standing:

 

Relief from Royalty Method (RRM)

It is based on the hypothetical royalty payments that would be saved by owning the asset rather than leasing or licensing it. This method is mostly used to value intangibles that can be tied to a specific revenue stream and where “data on royalties and license fees from other market transactions are available.”

 

Multiperiod Excess Earnings Method (MPEEM)

This method is a “variation of discounted cash-flow method.” MPEEM do not add those cash flows associated with a single intangible asset and measures fair value by discounting them to present value. This method is used primarily when one asset is the primary driver of a firm’s value.

 

With and Without Method (WWM)

WWM estimates an intangible asset’s value by calculating the difference between two discounted cash-flow models: one based on the “status quo” for the business with the asset, and the other without it. This method is often used to value noncompete agreements.


Real Option Pricing

It is used mostly for assets that have the potential to generate cash flow in the future but are not doing so now, such as undeveloped patents and/or undeveloped natural resource options. “As with stock options,” the article notes, “a key challenge in the valuation of real options is checking the underlying volatility.”

 

Replacement Cost Method, Less Obsolescence

It requires an assessment of the replacement cost of the intangible asset, which is then adjusted for an obsolescence factor relative to the intangible asset.