When you're considering determining the value of your business, you may hear the term business valuation methodologies. But what are they, how do they impact the final calculated value of your company and why is it important to know the differences between them? Here's a quick look at the most common valuation methodologies to help get you started.
What Are the Different Business Valuation Methodologies Used in Appraisal Practices?
Asset-based approaches look at what a business already has in terms of tangible and intangible assets and liabilities. These assets are then used to help determine the value of the business.
- Adjusted Net Asset Value Method - This requires the appraiser to adjust the company's assets and liabilities to their fair market value as of the valuation date.
- Liquidation Value Method - When a company is discontinuing operations or restructuring, the proceeds from liquidation are calculated using either an orderly or forced liquidation approach.
- Book Value Method - Though sometimes used, this method has serious flaws. It's an accounting number based on the value of assets on the books, but when equipment is fully depreciated before it's put out of service, it doesn't reflect a realistic business value.
- Excess Earnings Method - When a business has significant goodwill or intangible assets, this type of methodology is used to calculate earnings above a reasonable return on the business' tangible assets.
Income-based approaches to valuation look at how much money the company has coming in. The appraiser uses that income and projected future growth to determine the company's value.
- Capitalization of Earnings Method - When a company has a regular income, this method is used to convert the ongoing benefits of that business over an extended period of time to determine the overall business value.
- Discounted Earnings Method, or Discounted Cash Flow Method - With the terms used interchangeably, this method is used to determine value when a company has irregular income, cash flow issues or inconsistent growth to determine future value.
Market-based valuation approaches look at similar businesses. The valuation specialist then makes adjustments to value to reflect the subject company's situation.
- Guideline Public Company Method - Using financial data from publicly-traded companies, this methods uses the actual price investors pay for a minority interest in similar companies to the business being valued.
- Guideline Company Transactions Method - When companies are closely held, this method is used by using the value of companies with similar characteristics, including industry, size, products, services and location, as well as transaction dates of sale.
- Multiple of Discretionary Earnings Method - This method takes a similar company and divides the transaction value by discretionary earnings, at which point the subject company's discretionary earnings are multiplied by the same multiple that was calculated.
- Gross Revenue Multiple Method - This method divides the transaction price by the company's revenue, then similar companies are researched to determine a multiple, which is then used with the subject company's revenue to calculate value. It doesn't account for profitability, however.
By understanding the different business valuation methodologies, you'll have a better grasp of exactly what an appraiser is referring to when they're calculating your business value. This provides you with a much better understanding of the process and calculations involved, making you a much more active participant in the process.