Business Valuation: The big 3 approaches

It is said that business valuation is both art and science. The art part comes from the valuators experience and professional judgement. The science comes from the approaches and methods used in calculating the value. Today we want to focus on the science part. 

There are three (3) main approaches to valuations: Asset, Income, and Market. Under these three (3) approaches, there are various methods. Let us look at each approach in more detail. 

Asset Approach

The asset approach is often called the “floor value” of a business. This is because this method relies on valuing the tangible assets of the business less its liabilities. As this method does not consider the “earnings capability” of the underlying assets, it does not supply a good indicator of goodwill or cash flow value of profitable companies. 

Income Approach

The income approach looks to determine the value of a business based on cash flows and applying an expected rate of return an investor would expect to receive. The two (2) main methods are Capitalization of Cash Flows, which uses history as a sign of the future, and Discounted Cash Flows, which uses projections of the future to determine value today. 

Market Approach

The market approach is much like the income approach where cash flows of a company being valued are determined and then multiples are applied to arrive at a value. This method looks to use other companies such as publicly traded companies or transactions from companies in the same industry to determine multiples. This is often what we see in the stock market. For closely held businesses this can be much more difficult depending on the size of the company being valued and the industry. 

Why understanding approaches matters

Having a basic understanding of the three (3) approaches to valuing a business lays the groundwork for understanding the value of a business and the story the methods tell. There are many services today that strive to offer quick, convenient, and low cost business values. However, understanding valuation theory, principals, and standards are some of the keys to providing meaningful valuations. Working with a valuation professional can help you achieve the most accurate value for your needs.

I’m Gregory M. Clark, MSA, CPA, CVA, MAFF of GMC & Company. I help attorney’s and their clients in litigation matters with business valuation, litigation support, forensic accounting, and consulting. If you have a shareholder dispute, or are going through a divorce and need a business valuation or forensic services, let’s talk! Call us at 219-554-9700 or email us at info@gmcandco.com. 

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