When we talk about business valuation, most people’s minds jump straight to big, abstract concepts: goodwill, cash flow, or market positioning. But there’s one foundational piece of the puzzle that often gets overlooked—the tangible assets. These are the physical pieces of the business that provide a backbone to its overall value, and understanding how they contribute is a critical first step in getting a clear picture of what your business is truly worth. Let’s break it down.
What Are Tangible Assets?
Tangible assets are exactly what they sound like: physical items that a business owns and uses in its day-to-day operations. Think of things like:
- Real property: land or buildings owned by the business.
- Equipment and machinery: the tools that help get the job done.
- Inventory: the products or materials on hand.
- Vehicles: but only those that are directly tied to business operations.
These assets represent a very real and measurable part of the business's overall value. Importantly, when we’re assessing the contribution of these assets to the valuation, we focus on their Fair Market Value (FMV) wherever possible.
Fair Market Value vs. Net Book Value
Now, here’s where things start to get technical (but I promise to keep it simple). When analyzing tangible assets, the ideal starting point is their Fair Market Value—essentially, the price someone would reasonably pay for the asset in its current condition in an open market. This is the truest reflection of what these assets are worth today.
But what happens when you don’t know the FMV? In those cases, the Net Book Value (NBV) shown on the business’s Balance Sheet can act as a reasonable proxy. NBV is essentially the original cost of the asset, adjusted for amortization (formerly referred to as depreciation). While it’s not always perfectly accurate—because markets fluctuate and amortization isn’t always linear—it’s a good starting point when FMV isn’t available.
Tangible Asset Backing: What’s Included?
When we’re calculating the tangible asset backing of a business, it’s not just about summing up all the assets. We’re also factoring in the liabilities tied to day-to-day operations. Specifically:
- Include: The FMV or NBV of all tangible assets that are directly required for the continued operation of the business.
- Exclude: Personal or non-operational assets (e.g., a vehicle owned by the business but used exclusively by the owner for personal purposes) and any excess assets (e.g., surplus cash that’s not required to maintain day-to-day operations).
Importantly, we subtract the value of operating liabilities, such as Accounts Payable, from the asset value. These are short-term obligations that the business must settle in the normal course of operations and, as such, they’re an essential part of this calculation.
What About Term Debt?
One common point of confusion is term debt, like mortgages on property or long-term loans tied to equipment. For the purpose of calculating the tangible asset backing, term debt is not netted against the value of the assets at this stage. While it’s certainly important, it comes back into play later in the valuation process when we’re considering the broader financial structure of the business. For now, we’re just focused on the gross value of the operational assets minus operating liabilities.
Why Tangible Asset Backing Matters
So why is this important? Tangible asset backing provides a baseline level of value for the business. It tells us the worth of the physical assets required to keep the business running—before we start considering things like cash flow or market dynamics. This is especially relevant in industries with high capital requirements, such as manufacturing or freight/logistics, where the tangible assets often form a significant part of the business’s overall value.
A Practical Example
Let’s bring this to life with an example. Say you own a small manufacturing business. Here’s what your tangible asset calculation might look like:
- Real property (factory building): FMV $1,000,000
- Machinery and equipment: FMV $500,000
- Inventory: FMV $300,000
- Vehicles: FMV $50,000
- Operating liabilities (Accounts Payable): $200,000
Tangible Asset Backing = $1,000,000 + $500,000 + $300,000 + $50,000 – $200,000 = $1,650,000.
Notice that in this example, we did not factor in any term debt, like a mortgage on the factory property. That’s because we’re isolating the operational asset value first.
Beyond Tangible Assets
While tangible assets are an essential piece of the valuation puzzle, they’re just one piece. This calculation doesn’t account for the business’s ability to generate cash flow, the strength of its market position, or the risks associated with its operations. These factors, along with any non-operational or excess assets, are layered in later as we move toward a comprehensive valuation and will be explored in the subsequent parts of this series.
Final Thoughts
Tangible asset backing might not be the most glamorous part of business valuation, but it’s a critical foundation. Understanding what it includes—and just as importantly, what it doesn’t include—helps you get a clearer picture of your business’s starting value. And once you have that, you’re better equipped to start managing the factors that contribute to sustainable growth.
Authors: Colin Szemenyei and Gary Sanghera, CPA, CMA, CBV
