If you talk to a professional business appraiser, it won’t be long before you hear about the business valuation approaches and methods. These are the tools of the trade – and it is important to understand their relationship.
Business appraisers enjoy having an arsenal of tools at their disposal. This gives them the flexibility to appraise just about any type of business or professional practice. Much of the appraiser’s expertise is in the proper selection of the right tools for each assignment.
Being highly organized people, the business appraisers like ordering things. So here is the basic taxonomy of the business valuation tools.
Business valuation approaches
At the top of the pile are the three ways to measure the value of a business:
- Asset Approach
- Income Approach
- Market Approach
Each approach lets you adopt a different view of what a business is worth. As the name implies, the Asset Approach looks at the values of business assets in order to determine the value of the entire company.
The Income Approach lets you measure the value of a business based on its ability to generate earnings at an acceptable level of risk.
Finally, the Market Approach offers you the way to estimate the market value of your business – by comparison to similar businesses that have recently sold.
Business valuation methods
When it comes to the actual calculation of business value, the business appraiser reaches to an array of techniques known as methods. Each major approach has a number of methods under it. The methods are the actual computational procedures you can use to calculate the monetary value of your business.
Here are the major business valuation methods grouped around their approach:
Asset-based business valuation methods
Income-based business valuation methods
- Discounted cash flow method
- Capitalization of earnings method
- Multiple of discretionary earnings method
Market-based business valuation method
Best practice: multi-method business valuation
The methods differ in the fundamental approach and the details of the calculations. Since no method is better than the others, well-prepared business appraisals use a number of methods to round out their conclusion. Using a set of methods under each Approach is the best way to “cover all bases” – and get a highly accurate, defensible business appraisal.