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

Business Valuation Appraisal Methodologies Appraiser

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

What are the small business valuation methods and how are they different?

Posted by Business Valuation Specialists LLC on Apr 25, 2018 1:41:00 PM

When you're considering having your company appraised, one thing that may not have come to mind yet are the different small business valuation methods. But what are they, how are they different and which one should be applied to your particular situation? Here's a quick overview of the most common methods used and how they're applied to your company's situation.

What are the small business valuation methods and how are they different?

There are three primary approaches to small business valuation: asset, income and market based. However, there are a number of different methods under each approach.

Asset-Based Approaches

Generally speaking, asset-based approaches don't work well for companies that are running in the black, but may be used in companies that are failing.

Adjusted Net Asset Value: This requires the appraiser adjust the company's assets and liabilities to fair market value.

Liquidation Value: When a company discontinues operations or restructures, the proceeds are calculated using the premise of an orderly or forced liquidation.

Book Value : Though it's sometimes used, this method has some flaws. It's based on accounting figures but often doesn't reflect the asset's actual value due to depreciation schedules.

Excess Earnings: This method combines asset and income based approaches by calculating earnings to measure intangible business assets as an extension or multiplier above a reasonable asset value.

Income-Based Approaches

An income-based approach has two methods depending on whether income is steady or inconsistent. The company's income over a period of time is multiplied to determine its overall value.

Capitalization of Earnings: When a steady income is the norm for a business, this method uses adjustments to normalize the income stream of a business for a single period, and then multiplies that benefit over a longer period of time.

Discounted Earnings: Also referred to as discounted cash flow, this takes an inconsistent or irregular income for a company and converts it to determine the current value of future income benefits for that company.

Market-Based Approaches

This type of approach uses current market conditions to determine the value of a business, whether based on income, a similar business or overall transactions.

Guideline Public Company: A similar publicly-traded company allows the appraiser uses the price investors paid for minority interests in that company and adjusts it to match the private company that's being appraised.

Guideline Company Transactions: A similar company that's closely held is used as a basis for the appraised company, with transactions analyzed and adjusted to match the appraised company.

Multiple of Discretionary Earnings: Financial statements from small companies are adjusted to represent an owner-operator. It compares adjusted earnings to create a valuation multiple.

Gross Revenue Multiple: This uses a comparable company and divides transaction price by that company's revenue to create a multiple of gross revenue.

By having a better understanding of small business valuation methods, you can gain an appreciation of what exactly your business appraisal means, how it was calculated and in what situations it may or may not apply. However, the appraisal you receive and work from is only as good as the appraiser who calculates it and prepares the report. Make sure that the appraiser you use has a solid certification in business appraisal as well as experience in your industry before hiring them for the job.

Tags: small business valuation methods