Breakdown: The 3 Basic Methods of Business Valuation

There are three basic methods of valuing a business: asset approach, income approach and market approach. For owners in need of a valuation, it is important to understand the differences between the approaches and how those differences may impact company value. Our professional valuation services cover the gamut of simple (and free) to complex.

Asset Approach

Simply stated, the asset approach values the assets of the business. The value of the assets of a business are, however, not always easy to ascertain. For example, the value of the assets as stated on the balance sheet – “book value” – is almost always not the true value of the assets in the marketplace. If a business is being liquidated and the assets must be sold by next Friday, then the book value is not of importance. However, if the assets can be sold over a course of several months, then the value of these assets is closer to their fair market value (FMV). Most of the time, assets are valued at FMV, defined as the price that a reasonable buyer would pay a reasonable seller when neither were under pressure to buy or sell. Unless you are buying a business that is very asset intensive, marginally profitable, or losing money, the asset approach usually is not the best indicator of the true value of the business.

Income Approach

The income approach uses one or more methods to determine the value based upon the anticipated benefits of business ownership. Simply stated, the income approach determines the value of the anticipated stream of business income. Although entire books have been written on the subject, the most relevant discussion revolves around what are the earnings and what is the discount rate or capitalization rate applied to the earnings? Earnings, as discussed elsewhere, are the adjusted profits of the business.

Market Approach

The market approach determines the value of a business by comparing it to similar businesses that have been sold. Although not as complete or comprehensive as residential comparable sales, there are several very good databases of sold businesses. Businesses are seldom exactly the same, but grouping like businesses by type and or region make comparisons relevant. VR subscribes to these databases and often checks numerous sources to find like businesses. VR also has extensive comparable sales for similar businesses sold throughout their broker network. With the Market Approach, sales prices are defined by a multiple of earnings and/or revenues.

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VR Business Sales New Haven represents owners of businesses valued between $500,000 and $25 million or with annual revenues from $1 million to $30 million. The office provides exceptional merger and acquisition (M&A) advisory services to companies operating within a wide range of industry segments in Connecticut, Southern New England and Metro NY. Independently owned and operated, the office consistently ranks within the Top 10 of over 50 offices worldwide with the VR franchise network.