3 ways to measure your business worth
There are 3 ways, known as business valuation approaches, that you can use to measure the value of a business:
- Asset approach.
- Market approach.
- Income approach.
Each approach takes a different view of how business value is measured. To calculate business valuation results, professional business appraisers use a number of methods under each approach.
Picking your business valuation methods
It is a good idea to use several business valuation methods to calculate your business value. Each method has advantages and no one method is more accurate than the rest. Here are just some things to consider when picking your business valuation methods:
Asset-based methods such as the Capitalized Excess Earnings method work well when you need to determine the value of business goodwill. Also, these methods are an excellent choice if you need to allocate the business purchase price among business assets.
Income-based business valuation methods come in two flavors: direct capitalization and discounting. The direct capitalization methods, such as the Multiple of Discretionary Earnings method, are a frequent choice to value established small businesses with a solid history of earnings.
On the other hand, the Discounted Cash Flow method is very often used to value young start-ups or companies going through a period of rapid growth.
You may want to consider market-based business valuation methods if you need to defend your opinion of what your business is worth. Knowing what similar businesses sell for is often the strongest indication of a business’s fair market value.
Business value conclusion: combine your results into a single number
Don’t be surprised if the results your get from the different methods vary. The benefit of using several methods is to see what the business value is from different points of view.
To come up with a single number for business value, business appraisers use a weighting scheme. The result from each business valuation method gets a weight based on its relative relevance. For example, if you believe that market comparisons are very important in your situation, you can assign a higher weight to your market-based valuation result.
As an illustration, let’s say that you used 3 business valuation methods and got the following business value results:
- Discounted Cash Flow: $1,200,000.
- Capitalized Excess Earnings: $1,350,000.
- Comparative business sale transactions: $1,270,000.
You believe that the asset and income-based valuation results deserve an equal weight, while your market comparisons are twice as relevant. Here is your weighting scheme:
- Discounted Cash Flow: 25%.
- Capitalized Excess Earnings: 25%.
- Comparative business sale transactions: 50%.
Now you can multiply the business valuation method results above by their weights and sum it all up:
$1,200,000 x 0.25 + $1,350,000 x 0.25 + $1,270,000 x 0.5 = $1,272,500.
The result is your business value estimate.