Methods to Value a Business
There are three main methods to value a business. These methods included the income approach, market approach, and asset approach. Each method specializes in specific ways to arrive at a fair market value. A valuation expert uses these methods when valuing a business. It is important to know the value of your business whether buying, selling, or trying to grow. Let a professional help you understand the value of your business.
Peak Business Valuation, business appraiser, offers business valuations to companies across the nation. No matter the industry, Peak can help. We want to help you feel confident in your business transaction. A business valuation can also help you understand how to maximize the value of your business. To receive your business valuation, click the link below to schedule your free consultation.
There are two income-based approaches. The first one is the Capitalization of Cash Flow and the other is the Discounted Cash Flow Method. Both of these methods value a business based on the income the business expects to generate. The income approach is a real estate valuation method that uses the income a property produces to arrive at a fair market value. To calculate it, divide the net operating income by the capitalization rate.
Capitalization of Cash Flow
This method pays attention to current cash flow. A valuation expert uses the capitalization of cash flow when a business is steady in margins and growth. It is also often applicable for established businesses with steady growth rates. This method values a business as growing perpetuity.
Discounted Cash Flow
This method focuses on future cash flow. Discounted cash flow or DCF is an intrinsic value approach that focuses on the business’s indebted free cash flow in the future. It then discounts it back to the present day. A valuation expert uses this method when there is variation in the growth or position of the business. This method leaves room for variation in growth, debt repayments, margins, etc… So how does this work? After understanding the projected cash flow, the valuation expert discounts the cash flow using a discount rate.
The market approach values a business by analyzing similar transactions that occurred recently with similar assets (businesses). Finding similar comparables can be difficult as no two companies are the same. As such, a business appraiser will make adjustments to the business financials that they are valuing to better compare them to similar businesses.
It is impossible to find two identical businesses. Therefore, a valuation expert relies on the word “similar” for this approach. One of the difficulties with this method is the lack of data that is sometimes available. For small private companies, data can be limited. However, a valuation expert has access to private databases with thousands of comparable companies. Using these, the business valuator can make adjustments based on the details of the business they are valuing. This is as long as they can find enough information. The more experience the business appraiser has, the more applicable this approach can be. This is because an experienced business appraiser will have an understanding of many industries.
The last common method to value a business is the asset approach. You may have heard of the term, a company’s book value. Well, essentially, this is the asset approach. The asset approach comes from the balance sheet. It subtracts the liabilities from the assets, leaving the equity. Sometimes, a business appraiser may include or exclude intangible assets, depending on the situation. An important piece to the asset approach is adjusting net assets. Balance sheets include depreciation, which changes the value of assets. A business appraiser will make adjustments to the financials to account for these differences in order to arrive at a fair market value. A key point to remember is that book value is different than fair market value. To find that difference, incorporate the adjusted net asset method to arrive at the fair market value.
Each company in need of a business valuation will have different situations. That is why there are several methods to value a business. While one method will work for one company, it may not work for another. That is why it is so important to get a trusted professional involved. At Peak Business Valuation, we carefully consider the needs of each company before choosing which approach(s) are most applicable. It is very common to use several approaches or methods when valuing a company. Doing so gives the business appraiser a clearer picture of what the business really looks like.
Peak Business Valuation, business appraiser, is here for your business valuation needs. Our business appraisers use each method based on the needs of the business. Every business functions differently and no two companies are the same. This is why each valuation method is so important. For more information schedule your free consultation. We look forward to helping with your valuation needs.
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