Establishing the value of a business is an important consideration when planning to sell, merge, or raise investment. Valuators are trained to use certain methods that will ensure professional valuations are accurate. When you check a company’s financial reports, different methods reveal different aspects of value.

So, how do professional business valuation experts tackle their toughest jobs? We’ll unpack three key approaches right here. Understanding these methods helps business owners make informed decisions about their company’s worth. Each approach offers unique insights, and knowing when to apply them is crucial for accurate valuation.

1. Income Approach

One of the most common approaches that valuation professionals use is called the income approach. This method looks at how much money a business is expected to bring in later and reveals its actual worth today. Components like expected income, costs, and discount rates all play a role.

Valuation specialists start with historical financial data. They study past results to help them accurately predict how much money will come in later. You’ll look closely at revenue, expenses, and the profit left over. Then, they apply a discount rate to that data. It is the risk-adjusted rate for future earning potential. They calculate the business value by taking the future cash flows and discounting them to their present value.

This works well for businesses with steady, predictable income. This approach offers insight into how a business might handle its money. But to pull that off, you need accurate predictions and a sharp sense of market conditions.

2. Market Approach

The second most common valuation method is the market approach. This lines up a business alongside its market rivals—companies that recently changed hands or whose shares you can buy on the open market. It rests on the concept that comparable companies should trade at or near the same multiple of earnings or other metrics.

Figuring out what a company is worth means gathering facts from similar businesses. These “comparables” get a close look: their sales figures, earnings, and all kinds of other financial information. Experts actively seek companies that are alike in their scale, industry, and market conditions. 

The market approach is effective in active markets where sufficient data is available. You can see what the market is doing and understand supply and demand dynamics. But finding accurate companies for comparison can be difficult. Size, location, or business model differences may affect accuracy.

3. Asset-Based Approach

With the asset-based approach, you assess how much a company has in assets minus liabilities to get net asset value. You simply remove all your liabilities from total assets. Organizations possessing significant physical capital—such as real estate, equipment, or inventory—will find this system highly applicable.

Analysts start by listing assets such as property, equipment, and inventory. They will then determine the fair market value for each item. Total asset value is reduced by liabilities like debts and other obligations to calculate net worth.

Companies that are closing their doors or have numerous physical assets often choose this approach. It provides a clear picture of a company’s tangible value. However, it might not reflect the full value of intangible assets such as brand value or intellectual property.

Choosing the Right Method

Different methods to value a company come down to different criteria. A lot hinges on your specific business, how that market moves, and whether your available data is reliable. According to the U.S. Small Business Administration, choosing the appropriate valuation method depends on the business type, purpose of valuation, and available financial data. To really understand a company’s worth, you’ll often see professionals trying out several methods.

For example, a tech startup with high growth potential would likely align with an income approach. On the other hand, if you have a manufacturing firm with substantial physical assets, you may prefer the asset-based approach. For a retail business with a lot of similar businesses to compare to, the market approach might be the perfect fit.

The decision of choosing one method or another depends on the specific situation of the company. Valuation experts arrive at the value based on its intended use—whether for a potential sale, an investment, or legal planning.

Conclusion

Determining the accurate financial standing of an enterprise is a fundamental question for any owner. There are income, market, and asset-based approaches that professional valuation experts use to meet that objective. Each methodology has its own relevance and application. Putting these methods together gives experts a complete and accurate assessment. Because of this, everyone involved can confidently take their next steps.