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.

When it comes to determining the value of a company, many people, business owners included, consider only what the balance sheet says or what their local competitor sold for recently. But is that a valid way to determine what a business is truly worth? Not by a long shot. Here's our look at how professional business appraisers calculate the valuation of a company:

Behind Assets and Liabilities: How Professionals Determine Company Value

When a professional appraiser needs to determine the value of a company, the balance sheet approach is one of the last approaches used. Why? Because most businesses are far more than simply the sum of their assets minus the total of their liabilities. There are many factors, such as goodwill and reputation, position within the market and many other aspects that can affect the outcome of business appraisals. Here are two of the most commonly-used approaches to business valuations:

Income-Focused Valuation Methods

When a business is being bought or sold, the person who is selling the business is losing future income. For this reason, many businesses are appraised using an income-focused methodology that takes that income into account when determining the final value for the business. Two different methods are used to calculate the appraised value, specifically based on whether the company's income has remained steady or has been irregular in the past:

• The discounted earnings or discounted cash flow method is used when income has been irregular or periods of growth are irregular, and is used to determine the current value of future income.
• The capitalization of earnings method projects the steady growth of the past into the future to determine the current value of that income.

Market-Focused Valuation Methods

The market-focused approach takes into consideration what similar companies have sold for in the market, but customizes the sale figure to the business being appraised. The company used for the baseline may be a similar publicly-traded company or have similar transactions, earnings or revenues to the company being appraised. Common methods used include:

• The guideline public company method, which uses the price paid for minority shareholders in a similar public company in the industry and adjusts it to the company being appraised.
• The guideline company transactions method, which compares the sale price of companies that are of similar industries, size, location and products or services offered and makes adjustments to account for the differences between the sample company and the business being appraised.
• The multiple of discretionary earning method, which adjusts the financial statements from a small company by dividing the sample company's transaction value by its discretionary earnings, which is then used as a multiple for the company being appraised.
• The gross revenue multiple method, which is similar to the discretionary earning method in that it takes the transaction value but divides it by the sample company's gross revenue to develop a multiple for use in the company being appraised. This can be a poor choice if the sample company and the company being appraised are not similar in terms of profitability.

As you can see, there is much more involved in determining the value of a company than simple bookkeeping or real estate values can provide. The best way to ensure your company is receiving a quality business appraisal is by working with a certified business valuation specialist.

When you are trying to determine the valuation of a company, one of the most important things that comes into play is the approach. Because business valuations are sought for a wide range of reasons, from selling to divorce to mergers, the approach must be customized to the particular situation. In this piece, we'll take a solid look at different approaches to determining company valuation and in which situations they're typically used. 

Different approaches to determining business value

Asset-Based Approach

Though asset-based business appraisals may seem like a good route to explore, they're typically only used in liquidation situations, not by healthy businesses planning on managing risk or expanding. Why? Because if you've spent years building your business and establishing a good reputation in your industry and region, you know that your business is worth much more than the sum of its parts. Asset-based approaches only figure the minimum liquidation value of your business assets instead of looking at the value of an established business in the community or the goodwill that it has created. For this reason, we virtually never used asset-based methodology to determine business value.

Income-Based Approach

An income-based approach uses the current value of future income to calculate a business appraisal. It looks at what the income has been in the past and projects it out for a period of years. The most common methods in this approach are capitalization of earnings and discounted earnings, also referred to as discounted cash flow.

• Capitalization of earnings takes into account the business earnings and is mainly used when results are steady.
• Discounted cash flow looks at the expected future business earnings putting more weight in near years versus out years.

Market-Based Approach

By comparison, the market-based approach looks at substitution. The appraiser looks at how much similar businesses have sold for, then adjusts the sale price on the differences between your business and the ones being analyzed. Because the businesses have things in common being in related industries, it is a good method to see what actual acquirers pay.  The most commonly-used methods are as follows:

• Guideline public company looks at a similar public company compared to your private company. If you are valuing a small business, this might not be the best way to compare entities.
• Guideline company transactions take similar companies with similar transaction levels and then adjust for any differences. The transactions are then applied against a multiple to determine the value of the company.  Databases provide details of small business transactions.
• Multiple of discretionary earnings looks at similar companies and what kind of discretionary earnings they make, then adjusts it to the company being appraised to determine business value.
• Gross revenue multiple looks at the gross revenue of similar companies and adjusts it to the company under appraisal, then uses a multiplier to determine value.

By knowing the different approaches, you gain a better understanding of how valuations work and why your appraiser is selecting a particular method.