3 Common Business Valuation Methods
A business valuation is an essential process to determine the economic value of a company which can be used under certain situations such as selling of the business, need of debt, and to add shareholders. Whatever is the reason behind the valuation, performing a business valuation will help you find and set an appropriate price for your business.
As a seller, one will always expect an expert business valuation opinion. It is a common procedure used to determine what your business is worth.
Essentially, there are three recognized approaches that can assist you in determining the value of your business.
- Asset-Based Approach
- Market-Based Approach
- Earning Based Approach
- Asset-Based Approach: This approach is processed by tabulating the market values of assets and liabilities of the company or business. You need to total up all the investments in the company to make the right estimate. By observing the company’s balance sheet, proper examine is taken to subtract total liabilities from the business assets and the book value is determined. This approach is applied when valuing an investment or real estate entity where all business income is attributable to the owner or key person.
Otherwise in another method known as “liquidation asset-based approach”, the net cash or liquidation value that would be received after all assets were sold and liabilities paid off. This approach is mostly used when valuing securities of businesses is involved in the development and sale of real estate or investment holding companies for a controlling interest.
- Market-Based Approach: In this approach, the business’ value is compared with a similar company or business sold recently. You get an observable value for your business by comparing the current value of the business with similar ones by looking at trading multiples. It allows businesses to compare financial information across similar companies to understand the current worth. More similar business to compare more accurate results of this method will be determined.
The market-Based Approach helps in getting the estimate of the subject business value and establish an accurate value for your business. You will know the value of your business’s assets that gives you a reasonable asking price by estimating the market value of the closely-held entity.
Common methods used under this approach are the Dividend-Paying Capacity Method, Guideline Merged & Acquired Company Method, Guideline Publicly-Traded Company Method, and Transaction Database Method. These can be used for publicly-traded or privately-held companies.
- Earning Based Approach: In this approach, the value of the present economic income is assumed to be the future economic income. It is expected from the business to generate the same wealth and return in the future from investments. The value is usually based either on historical earnings or the expected value of future cash flows.
Even the investor risk and hazards for business are analyzed in the form of Discounted Cash Flow (DCF) and capitalization of economic income at an appropriate rate of return. Depending on the level of income, capitalized economic income or the DCF method can be used. DCF analysis is a financial model that is built-in Excel with total detail and analysis. The value is determined based on different scenarios, and can even perform a sensitivity analysis.
On the other hand, the capitalization factor determines what rate of return a reasonable purchaser would expect on the investment.