Business Valuation Blog | Understanding Buying / Selling a Company

Approaches and Methodologies Considered When Appraising Your Business

Posted by Business Valuation Specialists LLC on Jan 3, 2022 7:00:00 AM

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Business owners likely have particular ideas about the value of their company and how best to calculate it, given their experience and knowledge of their financial history, and understanding of the market and industry in which they operate. When you need to formally engage an experienced, certified business appraiser to value your company, it's important to understand the standard accepted approaches they consider and weigh during the process.

There are three approaches to business valuation, namely the Income Approach, the Market Approach, and the Asset Approach. Each of these methodologies can be broken down further and considered based on the type of business you own, available data to analyze, and the company’s current operational status. Here is a brief summary:

Income Approach

The income-based approach has two primary methods that take into account whether the business income is steady or inconsistent. Essentially, the company's income is measured over a period of time to determine its overall value. Under a “Capitalization of Earnings” approach, the appraiser will consider both historic and future income probability, based on a steady stream of revenue, and discount these streams to realize a net present value, while using appropriate rates of capitalization.

Under the “Discounted Future Earnings” approach, the appraiser will estimate value primarily from future income probability, or forecasts, over a fixed period of time, to a terminal value, and discount this back to the present

Market Approach

>The Market Approach determines business value where the subject company being appraised can be compared to available businesses traded in the public marketplace. Adjustments are made to better match the private business based on revenue and overall size.

These guidelines are either investor-driven or transactional, depending on the data available. For example, a similar publicly-traded company may have available the price investors paid for minority interests in that company. This can then be adjusted to match the subject private business profile.

Other methods which take components of both the income and market approach are the “Multiple of Discretionary Earnings” and “Gross Revenue Multiple” which consider the actual income of the business being appraised and apply a market-derived multiple to these earnings based on available public data.

Asset Approach

As a general rule, the asset approach is considered and primarily weighed when a business is operating at a loss or has shut down temporarily or permanently. The options available to the appraiser under this approach are as follows:

Adjusted Net Asset Value: Under this methodology, the appraiser will adjust the company's tangible assets based on an estimate of Fair Market Value, while taking into account existing liabilities.

Liquidation Value: If the business has permanently ceased operations, and a compulsion to sell the remaining assets is the only remaining option, the value of the assets is measured under an Orderly or Forced Liquidation premise.

Book Value: This method relies solely on the net book figures of the assets recorded on the company’s books, without adjusting to market or liquidation value. Given accounting depreciation methods are usually accelerated, this will likely lead to undervaluing the assets.

Excess Earnings: This method takes into account the historic earnings of the company and provides a broad way to measure intangible asset value as well as tangible, by estimating the goodwill of a business along with personal property, equipment, improvements buildings, and land. This is generally preferred for fully operational companies with a lot of tangible assets.

By gaining a better understanding of these valuation methods, you will be able to work together with your certified, experienced business appraiser, in a successful fashion, to properly appraise your company.

Tags: business appraisal, small business valuation services, business valuation methods, small business valuation methods, Business Valuation Methodologies

Business Valuation Methodologies: How They Differ in Appraisals

Posted by Business Valuation Specialists LLC on Apr 29, 2019 8:00:00 AM

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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

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

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 Approaches

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.

Tags: Business Valuation Methodologies