Understanding the complete picture of a company’s assets and equity, in addition to liabilities and other obligations, is essential when bankers, lawyers, accountants and other professionals are performing due diligence in a strategic merger and acquisition (M&A) transaction.
While assets and equity both refer to value or ownership within a company, they are quite different. Let’s have a look at the differences.
Understanding Assets
An asset is a resource owned or controlled by an individual or organization. It is expected to generate a positive economic benefit. Common types of assets include current, noncurrent, physical, intangible, operating and nonoperating.
Correctly identifying and classifying the types of assets can be critical to a company’s survival, because asset identification provides an understanding of value and economics. Assets with a lower value than previously thought can serve as risks.
The International Financial Reporting Standards framework defines an asset as follows: “An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.”
Examples of assets include:
- Cash and cash equivalents
- Accounts receivable
- Inventory of goods, products and raw materials
- Investments
- Equipment, including furniture
- Real estate, including that which is used and not used for company operations
- Vehicles
- Patents and intellectual property, known as intangible assets
Properties of Assets
According to the Corporate Finance Institute, there are three key properties of an asset:
- Ownership. Assets represent ownership that can eventually be turned into cash and cash equivalents.
- Economic value. Assets have economic value and can be exchanged or sold.
- Resource. Assets are resources that can be used to generate future economic benefits.
Classification of Assets
Assets are generally classified in three ways:
- Convertibility: How easily they can be converted into cash.
- Physical existence: Whether they are tangible or intangible.
- Usage: Their usage or purpose by the organization.
Classifying assets is important to a business. For example, understanding which assets are convertible can help a company find opportunities to raise cash, which might be needed to pay for liabilities or engage in a transaction, such as purchasing another company.
Understanding Equity
In finance and accounting, equity is the value attributable to the owners of a business. In other words, equity represents ownership.
There are generally two types of equity value: book value and market value. According to the Corporate Finance Institute, the book value of equity is calculated as the difference between assets and liabilities on the company’s balance sheet, whereas the market value of equity is based on the current share price (if public) or a value that is determined by investors or valuation professionals. The account may also be called shareholders/owners/stockholders equity or net worth.
Book Value of Equity
In accounting, equity is always listed at its book value. This is the value that accountants determine by preparing financial statements and the balance-sheet equation: assets = liabilities + equity. That equation can be rearranged to: equity = assets − liabilities. (It is in this equation that many people mistake assets and equity.)
The value of a company’s assets includes assets that are current, noncurrent, physical, intangible, operating and nonoperating. The value of liabilities is the sum of each current and noncurrent liability on the balance sheet. Common liability accounts include debt and obligations, such as lines of credit, accounts payable, short-term debt, deferred revenue, long-term debt, capital leases and any fixed financial commitment.
Market Value of Equity
Market value is another measure of a company’s equity, and it may be higher or lower than the book value. The difference lies in the fact that accounting statements are backward-looking — all results are from the past — whereas financial analysts look forward to the future to forecast what they believe financial performance will be.
For publicly traded companies, the market value of the equity is calculated by simply multiplying the latest share price by the total number of shares outstanding. For private companies, the calculation is much more difficult. If the company needs to be formally valued, perhaps in preparation for a merger or acquisition, it will often hire investment bankers, accounting firms or valuation firms to perform an analysis based on industry knowledge.
The Best Solution for Virtual Data Rooms
Mergers and acquisitions are complex transactions requiring close, intensive review of hundreds of sensitive documents. Teams of professionals from all parties — including bankers, lawyers, accountants and other advisors working with the companies — need easy, secure access to these documents 24/7.
A virtual data room needs to be more than simply cloud document management. Instead, organizations should consider an enterprise document security solution like CapLinked that has years of experience providing data rooms for sensitive and complex M&A transactions and their integration afterwards.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, Jake covers such topics as security, mobility, e-commerce and the Internet of Things.
Sources
Corporate Finance Institute — Types of Assets
Corporate Finance Institute — What is Equity?
