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The Ultimate Business Valuation Methods Guide in 2024

The Ultimate Business Valuation Methods Guide in 2024

jeremiah grant
By - Jeremiah Grant
Last Updated - January 6th, 2024 11:26 AM
Jan 06

Have you ever wondered how much your business is worth? Knowing your business’s value is crucial for various reasons, whether you are looking to sell, raise capital, or simply want to understand your company’s financial health. But how do you go about valuing a business? There are many different business valuation methods to choose from, each with its own set of pros and cons.

In this ultimate guide, we will explore the three main branches of business valuation methods: the asset-based approach, the market value approach, and the income approach. We’ll delve into the details of each method, highlighting their advantages and disadvantages based on insights from our own business appraisal services and help you determine the best approach for your specific business.

Not just that, next, we will look at 12 commonly used methods of company valuation that come under the three main branches.

So, how do you accurately value your business? Let’s find out.

Business Valuation Methods infographics

What is Business Valuation?

It is a process that involves estimating the economic value of a business enterprise. It is used by entrepreneurs, investors, and other stakeholders to make decisions related to the business. For example, business valuation can be used to assess the potential of a business, determine its fair market value for sale, or calculate the cost of equity for a company. Professional appraisers typically conduct business evaluations. They involve analyzing a company’s financial statements, such as income statements and balance sheets, and other factors, such as industry trends, competitive landscape, and economic conditions. In addition, business valuation analysis provides an estimated value for the business that can be used to make informed decisions related to its future.

You might also want to read: The Ultimate Business Valuation Guide for 2024

Why Would You Need a Business Valuation?

There are several reasons why a business owner (probably you, if you’re one) may need a business evaluation. Here are some of the most important ones:

Selling your business:

You may need a business appraisal if you are looking to sell your business. This is because a business valuation can provide an accurate assessment of the current worth of your business and help you determine an appropriate asking price. It can also indicate the potential value of your business in the future. Additionally, this valuation can help you identify areas where you can improve your operations and maximize the value of your business. Ultimately, this will result in a better return on investment when selling your business.

Raising capital:

If you’re looking to raise capital, you need to know the true value of your business. This is where a business valuation comes in. A business valuation is an important tool for entrepreneurs looking to secure funding from investors and lenders. A professional business valuation will provide you with an accurate assessment of the company’s worth. This helps determine the amount of capital that can be raised and informs negotiations with potential investors. Knowing your business’s value helps you set realistic expectations for yourself and investors when it comes to raising capital.

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Mergers and acquisitions:

When it comes to mergers and acquisitions, a business valuation is essential. A business valuation will provide you with an accurate assessment of the value of your business, which is essential for negotiating a fair price when merging with or acquiring another company. It will also help you determine the best way to structure the deal and understand the financial implications of making such a move. Additionally, a business valuation can help you identify risks associated with the merger or acquisition and ensure you get good value for your money.

​​​​​Succession planning:

When it comes to succession planning, you will need a business valuation. A business valuation is essential in transferring a business from one owner to another since it provides a realistic assessment of the company’s worth and helps determine how much the buyer should pay for the business. The valuation also helps to ensure that the buyer pays a fair price for the business. Furthermore, a business valuation will provide you with valuable insights into your company’s financial health, enabling you to make informed decisions about succession planning.

Divorce or legal disputes:

It is important to get an accurate business valuation if you are in the midst of a divorce or legal dispute. This will help determine the value of the business assets so that each party can receive a fair share of the assets. A business valuation can also clarify any disputes over the ownership of certain assets and provide an objective assessment of the value of the business. A business valuation can also be used to determine the best approach for dividing up the assets. This is especially important if one or both parties are planning to keep some or all of the assets.

Tax planning:

A business valuation can be a valuable tool when it comes to tax planning. By obtaining an accurate assessment of the value of your business, you can ensure that any taxes you owe will be based on the true worth of your company. Additionally, a business valuation can help you properly structure your transactions to take advantage of any available tax breaks and deductions. A business valuation can also provide insight into how to best structure your business operations for maximum financial benefit.

Corporate financial reporting:

Business valuation is a critical aspect of corporate financial reporting as it helps to provide a comprehensive assessment of a company’s current and potential future value. This information is essential for investors and stakeholders as it allows them to understand the company’s financial position and growth prospects.

Having a reliable business valuation can also aid in decision-making processes related to resource allocation, capital expenditure, and financial reporting structure. In addition, business valuations can be used to determine the fair market value of a company when it comes time to make strategic decisions, such as mergers and acquisitions or financing options, or when the business is being sold. Finally, a credible business valuation objectively assesses the company’s worth, which can be a valuable guide when making these critical business decisions.

You might also want to read: Business Appraisal Benefits: How to Make the Most Out of It?

Three Main Branches of Business Valuation Methods

The methods of company valuation are used to determine the worth of a company and can be classified into three main categories: asset-based, market value, and income-based. These business appraisal methods consider different aspects of a company’s financial performance and potential, such as its assets, market conditions, and future earnings potential. The choice of methods of valuing a business will depend on the specific characteristics of the company being valued and the purpose of the valuation. Therefore, it is important to consider the strengths and limitations of each method and to choose the most appropriate one for the specific situation.

1. Asset-Based Approach

Asset-based company valuation methods focus on the value of a company’s assets, including tangible assets such as property, machinery, and inventory, and intangible assets such as intellectual property and brand value. These methods are often used for companies with a solid tangible asset base, such as manufacturers or real estate firms.

Top companies by asset in USA infographic

Pros of Asset-Based Approach

Here are some important pros of the asset based valuation method:

  • Easily applicable: It is relatively easy to use and can be applied to various businesses. It also requires minimal research, making it an ideal choice for those with limited time or resources.
  • Objective: The asset-based approach provides an objective evaluation of a company’s worth, as the assets are valued based on their market value. This eliminates the potential for personal biases or subjective opinions to influence the valuation.
  • Flexible: It can be adjusted to fit different situations and scenarios, allowing it to be used in a wide range of scenarios. Additionally, it can be used to value companies with varying economic stability or profitability levels.

Cons of Asset-Based Approach

Here are some cons of the asset based valuation method:

  • Limited scope: This approach only considers the value of a company’s assets and does not consider other factors, such as market conditions or future earnings potential. It can lead to an incomplete picture of the company’s value and may not accurately reflect its true worth.
  • Difficulty valuing intangible assets: Intangible assets such as intellectual property and brand value can be challenging to quantify and assign a monetary value to. This can lead to inaccuracies in the valuation process and potentially result in underestimating the company’s value.
  • Limited usefulness for service or technology companies: It may not be as applicable to service or technology companies, which often have a higher proportion of intangible assets and may not have a significant tangible asset base. This can make it challenging to value these types of companies using this approach accurately.

 

You might also want to read: A Complete Guide on Business Valuation Asset Based Approach

2. Market Value Approach

The market value-based company valuation methods rely on market conditions and comparables to determine the value of a company. It takes into account the demand for the company’s products or services, as well as the company’s competitive landscape. Businesses with a strong brand or a unique product or service offering often use this approach.

Top 10 companies by market cap in usa info

Pros of the Market Value Approach

Here are some essential benefits of the market value approach:

  • Reflects current market conditions: The market value approach uses current market prices and conditions to determine the value of a business. This can be useful when the company’s value is expected to fluctuate based on market conditions.
  • Widely accepted: It is a widely accepted method for determining the value of a business. This means that it is generally accepted by financial professionals and is likely to be understood and accepted by potential buyers or investors.
  • Provides a benchmark: This approach can provide a benchmark for comparing the value of similar businesses. It becomes beneficial for investors or business owners considering acquiring or selling the business and want to understand how it compares to similar companies in the market.

Cons of the Market Value Approach

Here are the cons of the market based valuation method:

  • Likely it may not accurately reflect intrinsic value: It relies on market prices, which may not accurately reflect the intrinsic value of a business. For example, market prices may be influenced by factors such as investor sentiment, which may not be based on the company’s underlying value.
  • Might not consider specific circumstances: It uses market prices to determine the value of the business, which may need to take into account particular circumstances or characteristics that could affect its value. For example, a market based valuation method may not consider the value of a unique intellectual property or a strong brand.

You might also want to read: A Complete Guide To Understand Business Valuation Market Value Approach

3. Introduction to Income-Based Approach

Income-based company valuation methods focus on the company’s future earnings potential. These methods consider the company’s revenue, profitability, and growth prospects to determine its value. In addition, income-based business appraisal methods are often used for companies with a strong track record of profitability and growth, such as service or technology firms.

Top 10 companies in USA by revenue

Pros of the Income-Based Approach

The following are some important pros of the income valuation method:

  • Considers future cash flow potential: For businesses that are expected to generate a steady income stream over time, the income approach proves useful since it values the company based on expected future cash flow. It helps investors or business owners understand the potential value of the business based on its ability to generate income in the future.
  • Can account for risk: The income-based approach can consider the level of risk associated with a business, which can help determine its value. For example, a company with a higher level of risk may be valued at a lower multiple of its expected cash flow compared to a lower-risk one.
  • Can be used to value a wide range of assets: It can be used to value a wide range of assets, including businesses, real estate, and financial instruments such as bonds and stocks. This makes it a flexible tool for valuing different types of assets.

Cons of Income-Based Approach

Here are some potential drawbacks of the income-based approach to business valuation:

  • Limited to current and past income: The income valuation method only considers a business’s current and past income streams and does not consider potential future earnings.
  • May not accurately reflect the value of the business: The income-based approach does not consider other factors that may impact the value of the business, such as its assets, brand value, or market trends.
  • Can be affected by one-time events: The income-based approach may not accurately reflect the value of a business if it has experienced one-time events, such as a significant loss or gain that have impacted its income.
  • Does not consider the specific characteristics of the business: The income-based approach does not take into account the particular characteristics of the company, such as its management team or industry trends, which could impact its future performance.
  • Not suitable for businesses with irregular income: This approach may not be suitable for companies with irregular or fluctuating income streams, as it may not accurately reflect the value of the business.

Now, we will look at 12 valuation approaches professionals usually employ to conduct thorough and accurate business valuations.

Know the Real Worth of Your Business with Just One Click!

Our business valuation team offers a free 30-minute no-obligation consultation service to understand your needs and issues and provide you with the best solution.

Going Concern Approach

The going concern business valuation method is a common approach used to determine the value of a company. It is based on the assumption that the company will continue to operate in the future and generate profits.

To determine the value of a company using the going concern method, an appraiser will consider various factors, including the company’s financial statements, competitive landscape, and management team. They will also consider the company’s assets and liabilities and potential growth opportunities or risks.

One of the key considerations in the going concern method is the company’s ability to generate cash flow. This involves analyzing the company’s revenue streams, expenses, and profitability. The appraiser will also consider the company’s growth potential and any potential challenges or threats to its future success.

Overall, the going concern method is a comprehensive approach that considers the company’s past performance and potential for future success. It is often used with other firm valuation methods, such as the asset-based or market approach, to provide a more comprehensive view of the company’s value.

Book Value

The book value method of business valuation values a company based on the value of its assets. To determine a company’s book value, the values of all of the company’s assets are added up and then subtracted from the value of the company’s liabilities. The resulting figure is divided by the number of outstanding shares to arrive at the book value per share.

The book value per share represents the amount that each shareholder would receive if the company’s assets were liquidated and all of its debts were paid off. This method is often used to value mature, stable companies with strong balance sheets.

The book value method is a useful tool for comparing the financial performance of different companies within the same industry, as it helps to control for differences in the size and composition of each company’s assets and liabilities.

The formula for calculating the book value of a company is:

Book Value = (Total assets – Intangible assets – Liabilities) / Number of outstanding shares

Where:

  • “Total assets” is the total value of all of the company’s assets, including both tangible assets (such as real estate, equipment, and inventory) and intangible assets (such as intellectual property, brand value, and goodwill).
  • “Intangible assets” is the value of all of the company’s intangible assets, such as intellectual property, brand value, and goodwill.
  • “Liabilities” is the value of all of the company’s outstanding debts and other financial obligations.
  • “Number of outstanding shares” is the total number of shares of the company’s stock that shareholders currently hold.

Liquidation Value

The Liquidation Value approach is used to determine the value of a company if it were to be sold off or liquidated. It involves identifying the company’s assets, such as cash and inventory, and estimating their selling price in a liquidation scenario. The appraiser will also determine the amount the company’s liabilities, like debts and obligations, would need to be paid off in a liquidation scenario. The liquidation value is found by subtracting the value of the liabilities from the value of the assets and represents the amount left over for shareholders after the assets are sold, and the liabilities are paid off. This approach is generally used as a worst-case scenario valuation method but may need to accurately reflect the value of a company that continues to operate and generate profits.

The formula for calculating the liquidation value of a company is:

Liquidation Value = Total Assets – Total Liabilities

Where:

  • “Total Assets” refers to the sum of all the company’s assets, including its cash, investments, inventory, and fixed assets such as buildings and equipment. The value of the assets is based on their estimated selling price in a liquidation scenario.
  • “Total Liabilities” refers to the sum of all the company’s debts and obligations and the amount that would need to be paid off in a liquidation scenario.

Asset Accumulation

The asset accumulation method values a company based on the value of its assets. This method considers tangible assets, such as real estate and equipment, and intangible assets, such as intellectual property and brand value. To determine the value of a business using this method, the values of all of the company’s assets are added up and then subtracted from the value of the company’s liabilities.

The resulting figure is the net asset value of the business, which represents the value of the business to its owners. The asset accumulation method is often used to value businesses with significant physical assets and can provide a useful starting point for determining the overall value of a company.

The formula for the asset accumulation method is:

Net Asset Value = (Value of tangible assets + Value of intangible assets) – (Value of liabilities)

Where:

  • The “Value of tangible assets” is the value of all of the company’s physical assets, such as real estate, equipment, and inventory.
  • The “Value of intangible assets” is the value of all of the company’s intangible assets, such as intellectual property, brand value, and goodwill.
  • And, the “Value of liabilities” is the value of all of the company’s outstanding debts and other financial obligations.

Excess Earnings

The excess earnings method values a business based on its income above and beyond its normal earnings. This method adds the value of the company’s normal earnings to any excess earnings. The resulting figure is divided by the capitalization rate (the rate at which the company’s future earnings are expected to grow) to arrive at the value of the business. This method is often used to value small, privately-held companies that do not have a readily available market for their shares. It is based on the idea that a company’s future earnings potential is an essential determinant of its value. By considering both normal and excess earnings, the excess earnings method provides a complete picture of a company’s financial performance and allows for a more accurate valuation.

The formula for calculating the value of a company using the Excess Earnings approach is as follows:

Business value = (Normal earnings + Excess earnings) / Capitalization rate

Where:

  • “Normal earnings” is the amount of income the company generates from its normal operations.
  • “Excess earnings” is the company’s additional income above and beyond its normal earnings.
  • “Capitalization rate” is the rate at which the company’s future earnings are expected to grow.

Market Capitalization

The Market Capitalization approach is a method used to determine the value of a publicly traded company based on the current market price of its outstanding stock. Market capitalization, or “market cap,” is found by multiplying the stock’s current market price by the number of outstanding shares.

To determine market capitalization, an investor or analyst will first identify the current market price of the company’s stock, which can be found on a financial exchange or through a financial news or data service. They will then determine the number of outstanding shares, which can be found in the company’s financial statements or through a financial news or data service. The market capitalization is then calculated by multiplying the stock’s market price by the number of outstanding shares.

The formula for calculating the market capitalization of a company is as follows:

Market Capitalization = Current Market Price of Stock * Total Number of Outstanding Shares

Where:

  • “Current market price of stock” is the current market price of a single share of the company’s stock.
  • “Total number of outstanding shares” is the total number of shares of the company’s stock that shareholders currently hold.

Precedent Transactions

Precedent transactions, also known as comparable company analysis, is a business valuation approach that involves analyzing the financials and sale prices of similar recently bought or sold businesses. This approach involves finding companies in the same industry or with similar characteristics, such as size and revenue, and using their sale prices as a benchmark for the subject company’s value. The logic behind this approach is that the market value of a company is determined by what similar companies have recently been sold for.

This method can be useful in valuing a company because it considers real-world market conditions and buyer demand. However, it is important to consider differences between the subject company and the comparable companies to ensure an accurate valuation. Precedent transactions can be useful for business owners and investors looking to value a company accurately.

Know the Real Worth of Your Business with Just One Click!

Our business valuation team offers a free 30-minute no-obligation consultation service to understand your needs and issues and provide you with the best solution.

Capitalization of Earning

The capitalization of earnings method is a business valuation approach that values a company based on the amount of income it generates. This method is based on the idea that a company’s future earnings potential is an important determinant of its value. For example, it is often used to value businesses expected to generate consistent and stable earnings in the future.

To use this method, the company’s earnings are divided by the capitalization rate (the rate at which the company’s future earnings are expected to grow) to arrive at the value of the business. This method can be a valuable tool for valuing businesses. Still, it is essential to consider various factors that can impact the accuracy of the valuation, such as the reliability of the earnings and growth estimates used in the calculation.

The formula for calculating company value using the capitalization of earnings approach is:

Business value = Earnings / Capitalization rate

Where:

  • “Earnings” is the amount of income that the company generates from its operations.
  • “Capitalization rate” is the rate at which the company’s future earnings are expected to grow.

Discounted Cash Flow

The “Discounted Cash Flow” (DCF) valuation approach determines a company’s value based on its expected future cash flows. This approach is based on the principle that the value of a company is the present value of its future cash flows.

 

To determine the value of a company using the DCF approach, an investor or analyst will first forecast the company’s future cash flows over a period of time. The investor or analyst will then determine a required rate of return, which is the rate of return that an investor would expect to receive for taking on the risk of investing in the company.

Next, the investor or analyst will calculate the present value of the company’s future cash flows using a discounted cash flow analysis. This involves discounting the future cash flows at the required rate of return to determine their present value. The present value of the future cash flows represents the company’s value.

The formula for company valuation using the discounted cash flow approach is:

Business value = (Future cash flows / Discount rate) + Terminal value

Where:

  • “Future cash flows” are the projected cash flows that the company is expected to generate in the future.
  • “Discount rate” is the required rate of return that investors expect to earn on their investment. It is used to discount the future cash flows back to their present value.
  • “Terminal value” is the estimated value of the company at the end of the projection period, calculated using a terminal growth rate.

Earnings Multiplier

The Earnings Multiplier approach is a method used to determine the value of a company based on its earnings. This approach is based on the principle that the value of a company is related to its earnings and that companies with higher earnings are generally considered more valuable than those with lower earnings.

To determine the value of a company using the Earnings Multiplier approach, an investor or analyst will first determine the company’s earnings per share (EPS).

The EPS is calculated by dividing the company’s net income by the number of shares outstanding. Next, the investor or analyst will determine the appropriate earnings multiplier for the company, which measures the price-to-earnings (P/E) ratio commonly used in the market to value companies in the same industry. The P/E ratio is calculated by dividing the market price per share of the company’s stock by the EPS.

Finally, the value of the company is calculated by multiplying the EPS by the earnings multiplier.

The formula for valuing a business using the earnings multiplier approach is:

Business value = Earnings Per Share x Earnings multiplier

Where:

  • “Earnings” is the amount of income that the company generates from its operations.
  • “Earnings multiplier” is a number that reflects the market’s assessment of the company’s financial performance and growth prospects. It is typically derived from the sale prices of comparable businesses or the market values of publicly traded companies in the same industry.

Enterprise Value

The enterprise value valuation method determines a company’s total value, including its equity and debt. It is often used as an alternative to the market capitalization method, which only considers the value of a company’s equity.

To calculate the enterprise value of a company, an appraiser will first gather information about the company’s equity, including its market capitalization and any minority interests. Then, to determine the total enterprise value, they will add the company’s debt, including any long-term obligations such as loans or bonds.

The enterprise value method is a valuable tool for comparing the value of companies across different industries, as it considers both a company’s equity and debt. It is also helpful in evaluating a company’s financial health as it considers its assets and liabilities.

The formula for calculating the value of a company using the EV approach is as follows:

EV = Market Capitalization + Value of Debt – Cash and Cash Equivalents

Where:

  • “Market Capitalization” is the value of the company’s equity, calculated by multiplying the market price per share of the company’s stock by the number of shares outstanding.
  • “Value of Debt” is the total value of the company’s debt, including both short-term and long-term debt, such as loans, bonds, and other financial obligations.
  • “Cash and Cash Equivalents” are assets that are easily converted into cash, such as cash on hand, marketable securities, and other liquid assets.

EBITDA

The Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) approach is used to determine a company’s value based on its profitability. The EBITDA approach is based on the principle that the value of a company should reflect its ability to generate profits, regardless of the financing sources or the expenses incurred in doing so.

To determine the value of a company using the EBITDA approach, an investor or analyst will first calculate the company’s EBITDA, which is a measure of the company’s profitability that excludes the impact of interest, taxes, depreciation, and amortization.

The EBITDA is calculated by adding the company’s earnings before interest and taxes (EBIT) to the company’s depreciation and amortization expenses. Next, the investor or analyst will apply a multiple, such as the price-to-earnings (P/E) ratio, to the EBITDA to calculate the value of the company. The multiple is chosen based on the company’s industry and financial performance and is used to compare the company to others in the same industry.

Finally, the investor or analyst will adjust the company’s value for any cash or debt held to arrive at the final value of the company.

The formula for calculating the value of a company using the EBITDA approach is as follows:

Value of Company = EBITDA x Multiple

Where:

  • “EBITDA” refers to the company’s earnings before interest, taxes, depreciation, and amortization, a measure of the company’s profitability that excludes the impact of these expenses.
  • “Multiple” is a measure used to compare the company to others in the same industry. The multiple can be a ratio, such as the price-to-earnings (P/E) ratio, or a percentage, such as the return on equity (ROE).

Accreditation in Business Valuation

Accreditation in business valuation is a process through which individuals and firms can demonstrate their knowledge, skills, and experience in conducting business valuations. In addition, several major certifications and institutions offer accreditation in this field.

The American Institute of Certified Public Accountants (AICPA) offers the Accredited in Business Valuation (ABV) credential, considered the gold standard in business valuation accreditation. To earn the ABV, candidates must have a bachelor’s degree, meet experience requirements, and pass a comprehensive exam.

The National Association of Certified Valuation Analysts (NACVA) offers the Certified Valuation Analyst (CVA) credential, which is also highly respected in the industry. To earn the CVA, candidates must have a bachelor’s degree, meet experience requirements, and pass a rigorous exam.

In addition to the AICPA and NACVA, several other organizations offer business valuation accreditation, including the Institute of Business Appraisers (IBA) and the Canadian Institute of Chartered Business Valuators (CICBV).

So, if you want to ensure you have hired an expert, ensure they have one of the certifications mentioned above.

Finding a Business Valuation Professional

Professional business appraisers are essential for accurately assessing a business’s value. They offer an objective and unbiased viewpoint regarding the business’s assets, liabilities, cash flow, and other important aspects that affect its worth. These valuators use industry-standard valuation strategies and procedures to guarantee that the evaluation is fair and dependable. They also provide a dependable source of information for legal matters such as disputes or tax liability. Whether your search is for small business valuation methods or large enterprise valuation methods, there is an approach for every business size, and an accurate one can be used to make informed decisions about its future.

At Arrowfish Consulting, our certified business appraisers are knowledgeable and experienced in the valuation industry. We provide reliable, easy-to-use, and timely valuation services for our clients. Our team has over 100 years of combined experience and is an industry expert. Our professionals hold ASA, CFA, ABV, and CVA credentials. We are committed to providing high-quality and accurate business valuations, no matter the complexity. We have experience working with financial professionals, attorneys, and entrepreneurs. With our team of experts, you can trust that you will get the most reliable and accurate business appraisal services. Contact us today for a free consultation, and let us help you make the right decisions for your business.

jeremiah grant

Jeremiah Grant

Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.