There is no perfect valuation method that you can use since they have their advantages and disadvantages. But you can utilize the most suitable one depending on your business type and need. Three valuation methods that are mostly used for business valuation are 1. The Market Approach; 2. The Income Approach; and 3.The Asset Approach . We will discuss these in detail below.
- The Market Approach. For this approach, the data for comparable businesses are utilized to do the company valuation. The data are generated from the actual sales transactions or the average assessment of the industry. The ratios and multiples are used to derive the value of the evaluated company.
The market approach can give you a better assessment of how much the investors are willing to pay for a comparable business. However, we all know that no two businesses are the same. The two companies have distinct characteristics on their own. Also, it is a challenge to acquire reliable data to use for the valuation.
- The Income Approach. The income approach uses the cash flows or income produced by the business and is either capitalized or discounted to present value. The computed amounts would be the basis for the valuation of the company. The two methods for income approach are the Capitalization Method and Discounted Cash Flow (DCF). The capitalization method uses the average of the projected infinite cash flows and divided by the capitalization rate, while the DCF is discounting the future cash flows using the weighted cost of capital to compute for the net present value.
The income approach utilizes the income streams for the company valuation, which is one of the factors considered by investors. Also, the business is commonly evaluated based on its current and future ability to generate income streams. However, this method requires expertise in forecasting future cash flows and identifying the capitalization rate and discounted rate.
- The Asset Approach. It is computed by deducting the total liabilities to the total assets. The value of assets can be evaluated through its market value or its book value whenever it seems more fit for the company. But the book value will be adjusted to reflect the current valuation since it does not consider its current value and gains.
The asset approach is the easiest to use since its calculation is straightforward and does not include any projections or the use of a capitalization rate or discount rate. However, it can be costly in the company’s part as it needs to hire an expert in the valuation of assets. The asset approach also ignores the current and future earning capacity for it is out of consideration in this method. This approach is more fit to use for capital-intensive businesses such as real estate.
Given the pros and cons of the different valuation methods presented above, it always goes down to a point whichever is more applicable and can give the most accurate valuation for your business. Other companies used the combination of different valuation methods before making crucial decisions. There are widely available financial modeling templates prepared by eFinancialModels that would be helpful for your company valuation.