At its most basic level, a business valuation is a process of determining the value of a business. There are three approaches to valuation, and all three should be considered as part of a comprehensive valuation process:

  • Market approach – This approach considers the company’s value in relation to similar businesses in the marketplace. The two methods most commonly appropriate to use within the market approach are the guideline public company method and the transaction method. The guideline public company method uses pricing multiples for publicly traded companies that operate in similar industry(s) to the company being valued. The transaction method involves compiling a list of prior sales of businesses in the same or similar industry as the company being valued and using available pricing multiples to determine a value. This method is most commonly used for smaller, privately held entities.
  • Income approach – The income approach involves looking at a company’s net income and financial data. Historical data and forward-looking projections are used to establish whether a company’s financial performance is stable or heading toward an upward or downward trajectory. The same methodology is frequently applied to cash flow. After determining a company’s benefit stream, either a discount or capitalization rate is applied, resulting in an estimate of value.
  • Asset approach – The adjusted book value method measures all assets and liabilities to their current fair market values. To get a complete picture of a company’s net asset value, appraisals should be carried out on real estate and certain equipment. A company’s adjusted book value will also include assets that may not be reflected on its historical balance sheet such as customer lists, prospect lists, written business processes, patents and goodwill.

When preparing a valuation, all three approaches must be considered. The resulting values are evaluated to determine a final estimate of value using the best approach or combination of approaches.

However, different companies have different circumstances, and different industries lend themselves more to one type of approach than another. Consequently, a valuation professional must determine how much weight to give to each value. Sometimes equal weight is given to all three, and other times one methodology will be disregarded, with the value determined by the other two. For instance, the asset approach generally doesn’t make sense for a service-oriented business, since the value is in the services the business provides and not its equipment. But for a family farm, the asset approach will most likely rule because of the high value of land, which is often higher than the income being produced from it.