The leading business valuation associations, the American Society of Appraisers (ASA), the Institute of Business Appraisers (IBA), and the National Association of Certified Valuation Analysts (NACVA), all agree on three major approaches to business valuation: the Income Approach, the Market Approach, and the Cost Approach. Under each of these approaches there are several methods that might be employed to determine business valuation depending on the specific nature of the company being valued.
Valuation Approaches and Methods
The Income Approach involves valuation methods that convert future anticipated economic benefits (e.g., cash flow) into a single present dollar amount. Depending on the valuation method used, “Income” might be represented by after-tax profit, pre-tax profit, EBIT (earnings before interest and taxes), EBITDA (EBIT plus depreciation and amortization), or other cash flow measures. The two most commonly used methods under this approach are the Single Period Capitalization Method and the Multiple Period Capitalization Method.
The Market Approach involves valuation methods that use transactional data to help determine a company’s value. These methods might involve private company transactions, public company transactions, as well as public company valuation measures using current stock market data. The theory behind this approach is that valuation measures of similar companies that have been sold in arms-length transactions should represent a good proxy for the specific company being valued.
The Cost Approach, also known as the Asset-based Approach, involves methods of determining a company’s value by analyzing the market value of a company’s assets. This valuation approach often serves as a valuation floor since most companies have greater value as a going concern than they would if liquidated, i.e., the present value of future cash flows generated by the assets usually far exceed the liquidation value of those assets. This difference between the asset value and going concern value is commonly referred to as “goodwill”. An exception to this might be a low-margin business in a competitive industry that owns its real estate, which has appreciated over time due to its development value. In this case, the asset value may exceed the going concern value of the business.
The valuation methods discussed above represent some of the most commonly used by business valuation professionals to generate an opinion of value. Although considerable time and effort is involved in preparing formal business valuations, unfortunately the results may or may not reflect the “real world” value of a specific company if it were formally offered for sale.
Consulting a professional investment banker can best help you assess the true value of your company. These professionals will assess your company’s strengths and weaknesses and employ some of the commonly used valuations methods used by business valuators. They will also leverage their insight into the current marketplace to help determine financing availability and assess many other factors to determine your company’s potential value in the market place.