The Three Business Valuation Approaches

When you are trying to determine the value of a business, it’s not as simple as many other goods and services we buy and sell every day. The value of a business will often relate directly to the buyer’s goals and plans for that business. Some people run their businesses as hobbies and aren’t that concerned with profits, believe it or not. And some people turn their hobbies into businesses, and then become very interested in profits.

But if you’re currently a business owner and you think you may want to sell in the near future, you’ll want a professional business valuation advice from  an experienced and qualified business evaluator, or appraiser. But what are your goals, and which valuation approach is best for your business?

“Price is What you Pay – Value is What you Get” – Warren Buffet

Three Business Valuation Approaches

  • Asset-Based Approaches

Basically, these business valuation methods total up all the investments in the business.

Asset-based business valuations can be done on an ongoing concern or on a liquidation basis, and are the most basic types of business assessments. Depending on the nature of the business assets and their income producing capacity  this approach may or not work.

  • Income Approaches

These business valuation methods are based on the idea that a business’s true value lies in its ability to produce wealth in the future. I say it often – value is based on the future not the past. Past earnings may be an indication of future earnings. The Discounted Cash Flow method is the most common income approach as it considers the business expected future cash flow. This valuation method may be constructed in a way to highlight immediate cash flow and  long-term growth.

With this approach, a valuator determines an expected level of cash flow for the company and calculates the present value of such using a risk adjusted discount rate.  The discount rate reflects what rate of return a reasonable purchaser would expect on the investment, as well as a measure of the risk that the expected earnings will not be achieved.

  • Market Approaches

When an appraiser places a value on residential real estate, market value approaches are used because the house or condo is really worth what similar homes are selling for. For many businesses this may also be the best valuation approach. This approach will only work if there enough similar businesses to compare. If a business makes left-handed widgets for people who are over 6’5” tall and use the widgets to go rock climbing in freezing conditions then that’s a pretty rare commodity and there is likely limited guideline or comparable businesses.

Chances are that a combination of the three approaches will produce a comprehensive and accurate valuation for most businesses. The key is effective correlation and weighting.

The valuation experts at ValuationUSA are skilled in determining which approaches and methods are best based on knowledge and years of experience. You can contact ValuationUSA via the contact information below:

5810 78th Street, Suite 300 • Bloomington, MN 55439

Kirk Kleckner cell (612) 760-8400 • Office (612) 435-6240 • Fax (612) 435-6241