Oct 14 3 Most Popular Business Valuation Approaches And Methods
The essence of running a business is to create or generate economic value on an original investment. This is what is fundamentally called profit making and it’s a key driver to business growth and wealth creation. A typical business venture is a matrix of value-generating elements, such as the business assets, the workforce, and the various production processes — all interacting to increase business value. Business owners need to know the value of their businesses from time to time for routine business performance assessment or for other special purposes like to prepare for a prospective business acquisition deal. There are many different ways of assessing the value of a business or company. Whether it’s a colossal conglomerate or just a small storefront, professional accounting firms have ways of estimating the market value of any firm. The 3 methods discussed below are the most popular business valuation approaches used today.
Just as its name implies, business assets are used in this approach. Professional accounting and auditing firms calculate the value of the business based on its asset holdings. Also called the cost-based approach, this method uses the market value of the firm’s assets to work out its current business value. Notably, the firm’s liabilities are deducted from the assets during the calculations in order to come up with a feasible market value. This is the most objective business valuation method because it even takes into account the asset depreciation and replacement costs. It also considers the current liquidation value of the assets against the present value based on future cash generation. This is also called the goodwill value of the business and it’s usually higher with time.
The market approach involves comparing the business under valuation with the value of other similar businesses in the same field/industry. This method relies on various sources of market information such as recent buy-sell transactions, private & public company transactions, current stock market data, current market dynamics and conditions amongst active business buyers, and many other comparable business factors and market dealings within the industry. The market method uses current market data to calculate what is called the fair market value of the business, which is suitable for the willing buyer and seller. You can consult any established Clifton NJ auditing firm for advice and guidance regarding these market metrics and for professional assistance on overall business valuation methodologies.
This business valuation approach relies on the income generation trends of the firm. Although this method qualifies as the most basic financial approach because it is pegged on the fundamental doctrines of profit making in business, it is based on a very subjective operating premise where the auditor uses various financial projections to estimate or project value growth over time. The method uses a defined valuation formula to calculate the projected business growth rate of the company based on prevailing market conditions and the firm’s performance-based track record. There are two main income based approaches. The first one is called the capitalization method and it involves an initial calculation of a capitalization rate or factor. This is then used to work out or divide the expected earnings over time in order to get the current market value. There is also the discounting method, which starts by projecting the business value over a specified period of time in years. A discount rate representing the risk of earning the projected income is then determined. Finally you use this rate to calculate the present value of the business from its terminal value.