There are three main approaches that are used to evaluate the value of a business. These common methods for determining value include the Market Approach, Asset Approach, and Income Approach. These varying strategies are harnessed for business valuation, including stock prices, to help business owners make decisions related to buying, selling, and merging businesses. Whether you’re looking into buying a business, considering selling your business or looking to find the value of your business to provide to venture capitalists, knowing how to come to conclusions about the value of your business is crucial.

Business Valuations Explained:

From our What’s Your Business Worth page

“If it’s not time to sell and you’d like a business valuation for planning or other purposes, or you’re a buyer looking for help valuing a target company, then our certified business valuation service is for you. We’ll do a deep dive and prepare a certified business valuation (BCA)—which is required by lenders, CPAs, attorneys, and courts. Proforma Partners has been certified by the International Society of Business Appraisers as a qualified provider of official BCAs.”

Untangling the various tangible and intangible pieces of your company and knowing how to accurately compute their value is a bit messy and complicated. Business valuation involves using a set of measuring tools to determine the worth of a business. Business valuation isn’t always calculated by returns.

Brokers and buyers sometimes utilize community impact and intangible assets to help to determine a business valuation.

Let’s talk approaches..

Income Approach

The income approach is fairly straightforward; the business is valued based on its ability to generate income for the owners. This is also referred to as a business’s “economic benefit.” And within the income approach, there are several common ways for businesses to be valued based on their income:

• • Discounted Cash Flow
    This method considers several factors like required investments to maintain those cash flowed, net cash flows,  and the long-term potential sale price are all examined. On a basic level, the business is valued based on the amount of income it can generate over a set period of time.
  • Capitalization of Earnings 
    A business’s projected earnings are divided by the capitalization rate, which represents the risk(s) that the business owner is taking on by investing. By considering how likely it is that the business will generate returns over time, this values the business.
  • Multiple of Discretionary Earnings
    A bit more complicated, this is done by computing the value of the business via considering the discretionary income stream and multiplying it by a variety of factors that represent the owner, business and industry factors.

Asset Approach

An asset approach places a fair market value on what a business actually owns. This could be your equipment, real estate buildings and land, patents and trademark, or digital accounts such as particular URLs and Platforms. Anything a company could turn around and sell as-is, is generally be considered an asset.

There are two common methods of valuing a business by its assets:

• • Asset Accumulation Method
    To use this method, a business builds a basic spreadsheet and compares all its assets, both tangible and intangible, against all of its liabilities. The difference is considered the value of the company’s assets. Think of this as what money would be left over if a business sold off all of its equipment, intellectual property and physical location.
  • Capitalized Excess Earnings Method
    Take together the value of the tangible business assets with the “excess” earnings. The excess earnings are considered the earnings that do not come from tangible assets.

Market-Based Business Approach

The market-based business approach considers how much the market is likely to pay for a business versus the value of the profits or the assets. There are two main methods of computing this:

• • The Comparative Market Transaction Method
  • Guideline Publicly Traded Company Method

In both of these valuation methods, companies look at other businesses that are similar to their own business and see how much other businesses have sold for (similar to real estate comps). This can be useful for a business that plans to sell based on its brand, or which is considered to have more potential than its financials are likely to show.

Let’s Find the Value of Your Business

Even if you’re not planning on selling your business any time soon, having a comprehensive valuation of your business is a good idea. When you go to raise capital, whether that be through investors or small business loans, showing that you have a thorough understanding of the economics of your business will only benefit you.

And if you are looking to sell your business, then we at Proforma Partners can be of assistance there too!

Free Business Valuations – Schedule yours now!