Business people often ask us: “Are different business valuation methods used to value companies in different industries?” It is a very sensible question – after all the differences between, say, a manufacturing firm and a dental practice are profound.
Professional business appraisers have developed an elegant, powerful framework to deal with this challenge. At the core of this framework are a set of universal business valuation methods that can be applied to valuing any business.
All these methods are grouped under the three major approaches to business valuation:
- Asset – based on the values of individual business assets and liabilities.
- Income – based on the company’s earnings outlook and risk profile.
- Market – by comparing the subject business to similar companies, in the same industry segment, that have recently been sold.
There are several reasons why this business appraisal framework can handle any business:
- All standard business valuation methods consider the industry-specific value drivers.
- These valuation methods provide a consistent way to measure business value while accounting for the unique attributes of your business and its industry.
- Each standard valuation method offers a different way of measuring the business worth, complementing the results you get from other methods.
Support by major business appraisal standards
The power and flexibility of this business valuation framework have made it the de-facto standard in all professionally conducted business appraisals. In addition, the multi-method business valuation is supported by the key appraisal standards such as the USPAP, AICPA SSVS No 1, and the IRS Revenue Ruling 59-60.
Let’s take a quick look at the typical valuation methods that are used to value companies in just about any industry:
Asset based valuation methods
The Asset Accumulation method lets you determine the overall business value based on the valuation of individual business assets and liabilities.
Current market values of these assets and liabilities are used to create the appraisal of a business. Needless to say, these market values are defined by the industry-specific factors. Examples are prices paid for similar equipment, royalty rates charged for customer lists or licenses and property rental costs.
Capitalized Excess Earnings method is another asset based valuation technique that is especially useful in measuring the value of business goodwill. Again, the industry conditions affect the market value assessment of individual business assets along with the capitalization rates used by this method.
Income based valuation methods
This group of appraisal techniques is perhaps the best example of how the industry factors affect the business value. Both capitalization methods, such as Multiple of Discretionary Earnings, and discounting techniques, such as the Discounted Cash Flow method, require business risk assessment. The industry-specific risk is one element of the discount and cap rates used by these valuation methods.
Income based valuation also requires that you forecast business earnings. This will most certainly be affected by the trends in your industry segment.
Market based valuation methods
These appraisal techniques rely on comparison to sold businesses in your industry segment. As a result, the business value estimates reflect the industry conditions such as investor demand for similar companies.
As a rule, business investment requires careful assessment of industry-specific growth prospects and risk. Hence, by using the market-based valuation multiples derived from similar business sales, you are effectively relying on the judgment of other business people about what a company in a specific industry is worth.
Since each method takes a different view of business value, throwing several standard methods into the mix is a very good idea. In fact, the use of multiple valuation methods is expected of all professionally prepared business appraisals.