Whether you want to buy or sell a business, you need to know how much the company is truly worth. To understand this more accurately, you will need to engage in a formal independent business valuation, preferably completed by a certified appraiser. There are various approaches for determining value when performing a business appraisal, and the valuation professional can assist in understanding the best methodologies for the business involved. Here are some of the ways an appraisal is analyzed:

Market-Based Approach

For an active company, a market approach can be one approach that measures fair market value and overall position in a competitive environment. Within this approach, there are different methods to consider, including those for public and closely-held businesses, as well as basing it on a multiple of gross revenues or discretionary earnings. Depending on the specifics of the business, one or more of these approaches is utilized and weighed in the analysis

Income-Based Approach

An income perspective can be useful to value companies of all sizes and is particularly effective for firms that operate with a capital investment intensive structure. One method within this approach is the Discounted Cash Flow method, in which an appraiser gauges future revenue five years down the road, and discounts this to determine the present value and ultimately a fair sale price. This can be beneficial for companies that experience varying levels of cash flow and earnings each year.

A second method under the income approach is called Capitalization of Earnings and uses EBITDA (earnings before interest, taxes, depreciation, and amortization) to estimate a single point-in-time value for the company using its cash flow. This method can best work for operations that experience steadier cash flows and have demonstrated consistent growth.

Asset-Based Approach

This approach focuses primarily on the tangible assets of the business while making adjustments to the company’s book values and goodwill in an effort to estimate value for firms with high levels of capitalized investment, such as real estate machinery & equipment and personal property.

There are certain methods that can work best within this approach, with an initial focus on depreciated book values while adjusting for current market value using tangible asset appraisals to complement the business valuation

In summary, the business appraiser considers and weighs these approaches that factor tangible and intangible assets, revenues, profits, markets, industries, and all other relevant components into the equation, to reflect the overall value of the company. The appraiser may ultimately determine only one approach makes sense while in other instances utilizes several into the appraisal analysis to ensure the most reasonable conclusions.

Whether you're a seasoned pro at having your business appraised or are just considering having your first business valuation performed, there are any number of terms that show up during the process that can be confusing. One of those is market approach. Used to define the type of calculations that are used in determining the value of a business, this approach uses a range of information from publicly traded companies to provide a baseline which is then adjusted to your company's specific situation. Here's a quick look at this type of valuation approach and the key aspects you need to understand to get the most out of it. 

Keys to Understanding the Market Approach in Business Valuations

• Based on the principle of substitution, market approaches to valuation uses a recently sold similar public company and bases the final value of the appraised company against the public company's sale price. The business appraiser identified a good match, then compares the businesses to calculate your company's value as an equally desirable business from the aspect of ownership or investment.
• There are several common methods used to determine business value using this approach. The Guideline Public Company Method, which looks across the board at all the aspects of a publicly traded company that has recently sold, then adjusts those aspects to match the company that is being valued.
• The Multiple of Discretionary Earnings Method uses discretionary earnings as the yardstick against which the company to be valued is compared. It uses privately held companies versus public companies as the businesses are usually smaller in size.
• The Gross Revenue Multiple Method takes a look at a company's gross revenues to determine value. This allows business owners to receive the benefit of future business income at the time of sale, an excellent option for retirees who are getting out of a lifelong business or an entrepreneur who is ready to move on.  Like the Multiple of Discretionary Earnings Method it uses privately held companies versus public companies as the businesses are usually smaller in size.
• Generally speaking, market approaches are used most commonly when a company has been closely held for a number of years providing a guide for determining that value overall.

By understanding the key aspects of how market approach valuation works in a business appraisal, you can have a much better grasp of how your company's value is being calculated and what it means to your business. If you're ready to have a business appraisal performed, remember to only work with a certified business valuation specialist. This helps to ensure that the valuation report you receive is based on solid methodologies and accepted practices, giving you the best possible value for your investment.