How Do Valuation Inclusions and Exclusions Affect the Value of an Asset?

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Published Date:  05-02-2024   Author:   diksha-shastri
captainbiz how do valuation inclusions and exclusions affect the value of an asset

The dictionary definition of an asset states that it is something of value. Many different internal and external factors contribute to the creation of an asset. So, when you want to determine the true value of an asset, you need to evaluate these varied factors. It will result in deriving the monetary worth of the asset. Asset valuation happens for a lot of reasons including business evaluation and investment purposes. However, which factors to include and exclude from this valuation depends on the purpose and your asset as well. This happens because the valuation inclusions and exclusions affect the value of an asset integrally. 

In this blog post, we focus on understanding the impact of valuation inclusions and exclusions on the asset. For this, the first thing we need to do is understand what valuation inclusions and exclusions are. 

What are Asset valuation inclusions?

While considering asset valuation, certain factors are very important and integral to the core property of an asset. These types of factors will help in determining the true monetary value of that asset. Hence, these factors are valuation inclusions. Let’s see the different inclusions:

Asset Impact of Valuation Inclusion
Tangible Assets Real Estate;
Office space;
Machinery and Plant;
Inventory and Equipments;
Raw Material.
Intangible Asset GoodWill;
Patent;Trade Secret;Trademark;Copyrights;Client Relationships.
Financial Assets Stocks and Securities;

Cash;

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Bonds;

Mutual Funds;

Bank Deposits.

Investment In equity shares;

In Debt;

In Partnerships and collaborations

Also Read: Examples of Inclusions in the Valuation of Goods and Services

Impact of inclusions on asset value

Now we are aware of the asset valuation inclusions. From the list above, it seems to be evident that all factors of an asset that help in determining its actual value after wear and tear and consideration of its income generation power are valuation inclusions. However, we also need to know why exactly these are included in the valuation. Hence, we need to understand the impact of inclusions on asset value. Let’s check it out with examples! 

Real Estate

Real Estate can either be an empty piece of land or a commercial workspace. So, depending on the situation, you can ideally include the different additional inclusions to your real estate. This includes furniture and fixtures, such as couches, lighting equipment, etc. Based on the purpose of your real estate asset valuation, these inclusions can highly increase or decrease the worth of your property in the final report. 

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Equipment and Machinery

Machinery that you use to produce your final product with all additional equipment is evaluated on its depreciation over the years and its income generation properties. If you get the true projection of your equipment and machinery that contribute to your day-to-day business activities, the final business valuation report will be very reliable for different stakeholders, especially investors. Moreover, if the machinery is attached to commercial land or property, it will increase the value of that property. 

Intellectual Property

IP rights like patents, trade secrets, copyrights and trademarks are not generic properties. They do not have a physical presence. However, what these properties do have is the ability to increase the technological and innovative worth of your business. A grant in patent can increase the value of your business by billions! Moreover, IP rights like patent grants usually also attract investors due to their high income-generating capacity. 

Client Relations

When your business is successfully retaining most of your client base, it shows that you have maintained a cordial relationship with them. This also acts as an asset for your business. The income you generate from your retained clients helps in focusing on business growth. Moreover, the impact of this valuation inclusion leads to an accurate valuation and certain projections for the future. 

Inventory

For manufacturing businesses’ inclusion of inventory and raw materials will significantly impact the final asset valuation. This is more significantly applicable when the business and inventory are related to a product high in demand or unique and distinctive. 

From all these points, it is inevitable to state that the valuation inclusions impact the value of assets positively. However, these are not the only factors that matter. External factors like the market position, competitors’ valuation, demand and supply, etc will also impact the asset valuation at large. So, before deciding on the final inclusions, a study of the market at large is highly preferable.

Also Read: Understanding Inclusions in GST Valuation: A Comprehensive Guide

What are asset valuation exclusions?

While undergoing the asset valuation process in a business, certain obsolete factors are excluded deliberately. This happens when a factor may lead to a highly positive or highly negative financial valuation. So, it is ideal to remove it. Moreover, the major reason behind valuation exclusions is always the fact that certain factors are not integral or core and do not exactly contribute to the value of the asset. Let’s check the asset valuation exclusions: 

Category Valuation Exclusion
Non core Business Units Additional office space;

Empty piece of land;

Subsidiary office not core to business operations

Contingent Liability Pending or potential lawsuits;

Warranty and Guarantee claims;

Workers Compensation

Non Transferable Assets Goodwill of owner;

Goodwill of employee;

Skillset of employees

Non-Marketable Securities Personal equity;

Restricted Stocks;

ESOPs

Also Read: Examples Of Exclusions In The Valuation Of Goods And Services

The Effect of exclusions on asset worth

Certain exclusions are required in the asset valuation to reach the fair market operational value of your business. The effect of exclusions on an asset’s worth is that it may show a wrong and unfair projection of asset worth. So you must ensure all the exclusions are happening only after careful consideration of the purpose of valuation. Let’s see the different effects of exclusions on asset worth: 

Reduction in Book Value

Exclusion of assets like goodwill will reduce the book value of your company. Excluding this means you are lowering your book value. However, it is a very traditional approach as it allows one to see a fair picture of the asset’s worth without any unnecessary external factors. 

Reduced Market Value

When you try to exclude the non-marketable securities like private and personal equity stock, etc you make the market value lower than the book value of the business. When the value of your assets is lower in the market than it is in your books, it reduces the potential of selling that asset at a good value. 

Quality of Earning

Usually, it is advised to exclude one-time incomes and expenses from asset valuation. By doing so, you maintain a consistent earning quality of your business. At a glance, you may feel that this is not important. However, looking at the bigger picture, the exclusion of this will help in maintaining consistency in past data and comparison with similar market situations. 

Risk Mitigation 

Including unnecessary information in the valuation process will give inappropriate results. Moreover, the inclusion of contingent liabilities, earnings etc can hamper the analysis of risks. Hence, the effect of valuation exclusion on an asset’s worth will be that it helps in risk mitigation. When the numbers are true to the actual worth of your asset, you can make decisions related to risk mitigation with ease. 

Understanding the dynamic relationship between inclusions and exclusions

As a business owner when you want to know the financial health of your business, you need to undergo the process of valuation. As stated above, this process includes the total evaluation of all assets, finances, liabilities and more components of the business to derive a monetary value of the business. However, as a part of this process, some inclusions and exclusions of factors make the valuation even more accurate and suitable for your stakeholders. So, when you look at it in detail, you know that there is a dynamic relationship between the inclusions and exclusions of valuation. We will be able to understand this relationship in a better manner through the following aspects:

Holistic Perspective

A holistic perspective of valuation includes all assets and liabilities that are relevant to your business purpose. Moreover, exclude all the assets, liabilities, and every other component that is not core to your business purpose and operations. 

So, in this aspect, you include all the necessary things and exclude the ones that are not. It looks simple and is holistic. Hence, most of the time this serves the purpose of valuation for small business owners. Also, it makes balancing inclusions and exclusions in valuation easier. So, it will leave out the transaction-based elements at large. 

Studying the Operations

When you want to figure out the core operational and functioning value of your business, the valuation inclusions need to consist of all the core operational assets and liabilities of the business. Here, anything that is not core to the operation shall be an exclusion. This perspective of valuation will focus majorly on the assets that are core to your business operations. So, it will also show the company’s true income generation value.

Managing Risks

Many times the purpose of valuation is to assess the risks related to a business. Before investors invest their funds in a business, they need to figure out the risks associated. To achieve this purpose, you need a balance between the inclusions and exclusions that allow you to figure out all risk-inducing aspects of your business. So, the idea is to include all material and identifiable risks and exclude any contingent liabilities and non-material risks. 

Financial Report

Valuation also plays a very important role in the financial reporting mandates of a company. So, when the purpose of valuation is to facilitate financial reporting, you need to include all the basic and important financial information. This includes the cash flow, the financial statements, expenses, income generation from assets, and more. Here, exclusions will be non-material and non-financial aspects of the business. 

Significance of Comprehensive Valuation Practices for a Business

As we know by now the process of valuation is very core to the operations of a business. Moreover, no matter how small or big your business is, valuation will help you in paving the way forward. So, in that manner, it also becomes equally significant for a business owner to take appropriate measures for the valuation practices. Valuation aims to know the financial health of your business, in that case, the practices you follow must be fair and appropriate. Let’s see the significance of comprehensive valuation practices in the following aspects: 

Decision Making

With an accurate and comprehensive valuation report, you can make well-informed decisions about buying, selling or investing in a business. Moreover, this comprehensive valuation can also be useful for the business owner in making plans for the business. A comprehensive report will show you the areas of improvement as well. 

Reporting and Compliance

In India, a company has to undergo many compliance requirements. This includes financial reporting and more to the tax authorities of India or the Ministry of Corporate Affairs. Many times these authorities will have a requirement to see the financial health of the company. In that case, a comprehensive valuation will come to your rescue. It ensures that the projections and reports you submit to these authorities are true and fair. This will also save you from a lot of hefty penalties as a comprehensive valuation report is reliable. 

Measuring Fair Value

A comprehensive valuation report has the balance of appropriate valuation inclusions and exclusions. Hence, business owners and investors need to know the fair market value of the business. A fair market value is usually a price which makes sense for the buyer and seller, both. So, knowing the fair market value of a business will help in making the business more attractive to investors. 

Conclusion

To conclude, before moving ahead with the asset valuation process in a business, it is advisable to create a fine balance between the inclusions and exclusions. Especially, after because the exclusions and inclusions you choose have a huge impact on the value of your asset. So, it is ideal to get help from industry experts before moving on with the comprehensive asset valuation. 

FAQs

  • Which tangible assets are included in business valuation?

Tangible assets that are core to business operations such as machinery, equipment, real estate, office space, etc are valuation inclusions. 

  • Do different valuation inclusions affect the asset value?

Yes, the components you choose to include in your asset valuation will impact the final worth of your asset. 

  • Does the exclusion of components impact the asset value?

Yes, some factors are intentionally excluded from valuation as they lead to unusually high projections for the value. These exclusions usually help in lowering the worth of the asset, to its actual fair market value. 

  • What is an exclusion in asset valuation?

An exclusion in asset valuation refers to any such component of that asset, which is deliberately left out while calculating the total monetary worth of the asset.

  • Is it necessary to exclude factors from valuation?

Yes, it becomes important based on the specific circumstances. However, including obsolete components in your asset valuation will only lead to the generation of a false report.

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Diksha Shastri

Diksha is a seasoned writer of all things Law, Finance and Business. She aims to make things easy for the readers.

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