Business Valuation Methods

There are several methods of appraisal for each of the business valuation approaches.

Asset Based Approach

Adjusted Net Asset Value Method - This business valuation method requires that the appraiser adjust the assets and liabilities to the fair market value as of the date of the valuation. For example, tangible assets such as machinery and equipment are valued by qualified professionals and the values are used by business appraisers in the asset approach.

Liquidation Value Method - This business valuation method used when a company will discontinue its operations or restructure. The proceeds from the liquidation are calculated under an orderly or forced liquidation premise.

Book Value Method - This method is sometimes used but has serious flaws. Since book value is only an "accounting" number, it has little to do with the actual value of the assets. Companies can take advantage of accelerated depreciation to reduce taxes. This in effect reduces the value of the equipment to zero in the first year when the normal useful life may be much longer. Likewise, equipment could be depreciated over a longer span of years when it is no longer useful. Financial accounting depreciation is very different from equipment depreciation. Using the book value in a business valuation can provide misleading results.

Excess Earnings Method - This business valuation method calculates earnings that are considered above the reasonable return on the tangible assets. It is often used in measuring goodwill or intangible value of a business. It contains some components of the Income Approach.

Income Approach

Capitalization of Earnings Method - This business valuation method is used to convert a normalized ongoing benefit stream into a present value based on a single period. It is most appropriate when a company has a stable level of cash flow that is increasing at a relatively constant rate over a period of time.

Discounted Earnings Method (Discounted Cash Flow Method) - This method of business valuation is appropriate when a company is experiencing an unstable level of earnings or cash flow or is experiencing inconsistent growth rates. The discounted earnings method calculates the present value of all the future benefits.

Market Approach

Guideline Public Company Method - This valuation method uses financial data from publicly traded companies. These valuations are based on the actual price investors have paid for minority interests in companies in the same or similar line of business as the company being valued.

Guideline Company Transactions Method - This method is a calculation of value of closely held companies in the same or similar line of business as the company being appraised. Companies are selected that have similar characteristics to the subject such as industry, size, products or services, and location. Transaction dates are also examined with more recent transactions being more meaningful than dated business sales.

Multiple of Discretionary Earnings Method - Small company financial statements can be adjusted to represent an owner-operated business entity. This business valuation method compares the adjusted earnings of small business transactions. The transaction value is divided by the discretionary earnings for the comparable company. The subject's discretionary earnings is calculated and then multiple by the multiple.

Gross Revenue Multiple Method - Used sometimes for small businesses, this method divides the transaction price by the company's revenue. Comparable companies are researched to formulate a multiple of gross revenue. This multiple is then multiplied by the subject's revenue to calculate the business value. Though this method is easy to calculate, it fails to take into account profitable versus unprofitable businesses of similar revenue.

 

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