What Does Net Tangible Assets Mean?
Net tangible assets represents the amount of physical assets minus the liabilities present in a business. The calculation takes the difference between the fair market value of tangible assets (cash, accounts receivable, inventory, capital assets, etc) less the fair market value of all liabilities (accounts payable, debt, etc). Net tangible assets exclude intangibles such as goodwill.
Divestopedia Explains Net Tangible Assets
The level of net tangible assets in a business impacts the price that a potential buyer is willing to pay for two reasons:
- A company with high net tangible assets will have more available security to finance the acquisition; and
- A company with high net tangible assets reduces the risk of the investment.
Let's consider two examples. Two companies are both valued at $2 million based on their estimated future cash flows. Company A has net tangible assets of $1.5 million, and Company B has net tangible assets of $0.5 million. It is easier for an acquirer to obtain acquisition financing for Company A, because the business has significantly more assets to provide as security to a bank. Company A also presents less risk since there is a higher asset base available to liquidate if the company ever becomes insolvent.
A business owner in a capital intensive business should be aware of situations where the future cash flows generated by the assets do not justify their book or "appraised" value. For example, take a business that has net tangible assets of $5 million, but only generates future cash flows to justify a valuation of $4 million. In this case, to maximize value, the business owner should liquidate the assets rather than sell the business as a going concern.