5 Common Business Valuation Methods

What Exactly Is a Business Valuation?

A business valuation often called a company valuation, is the process of estimating a firm's economic value. During the valuation process, all aspects of a corporation are examined to evaluate its value and the value of its departments and units.

A company valuation may be used to estimate the fair value of any business for a variety of purposes, including determining sale value, establishing partner ownership, taxation, and even divorce proceedings. Owners frequently seek objective estimates of the value of their businesses from professional business evaluators.

The Fundamentals of Business Valuation

In corporate finance, the question of business value is regularly discussed. A business valuation is often performed when a company wishes to sell all or a portion of its operations, combine with, or buy another company. Establishing the present worth of a business using objective metrics and evaluating all areas of the business is known as business valuation.

A business valuation may include an examination of the company's management, financial structure, future earnings projections, or asset market worth. Evaluators, firms, and sectors all employ different tools for valuation. A review of financial statements discounted cash flow models, and similar company comparisons are common approaches to business valuation.

5 Common Methods of Business Valuation

The five most common business valuation methods are as follows:

1. Market Value Valuation Method

First, the market value business valuation method is likely the most subjective technique for determining the worth of a company. This method calculates your company's value by comparing it to similar firms that have recently sold.

Of course, this strategy only applies to companies that have access to market data about their competitors. In this regard, a market value method is a callous approach for sole proprietors, for example, because comparative data on the sale of similar enterprises is difficult to come by (as sole proprietorships are individually owned).

Having said that, because this small business valuation method is very imprecise, the value of your firm will ultimately be determined through negotiation, especially if you're selling your business or looking for an investor. Although you may be able to persuade a buyer of the value of your firm based on intangible attributes, this strategy is unlikely to be helpful in attracting investors.

Nonetheless, this valuation method is a solid starting point for determining how much your company is worth. Still, you'll probably want to bring another, more measured approach to the negotiation table.

2. ROI-Based Method of Valuation

An ROI-based business valuation approach determines your company's value based on its earnings and the potential return on investment (ROI) that any investor could obtain for investing in your firm.

Here's an illustration: If you pitch your company to a group of investors for equity financing, they will begin with a valuation percentage of 100%. If you ask for $250,000 in exchange for 25% of your company, you're using the ROI-based method to evaluate your company's value when you present this offer to investors. To explain, divide the sum by the percentage offered, for example, $250,000 divided by 0.25 to get your fast business valuation—in this case, $1 million.

The ROI approach makes sense from a practical standpoint—an investor wants to know their return on investment before investing. However, a "good" ROI is ultimately determined by the market, which is why business valuations are so subjective.

3. The Discounted Cash Flow (DCF) Method of Valuation

Although the three approaches discussed above are commonly considered the most frequent, they are not the only ones available. In fact, while the ROI-based and market value-based methods are highly subjective, some alternative approaches (which we'll discuss) use more of your company's financial data to determine its worth.

For example, the discounted cash flow valuation method, often known as the income approach, evaluates a company based on its future cash flow, adjusted (or discounted) to present value.

If your profits are not likely to be steady in the future, the DCF approach can be especially valuable.

4. Capitalization of Earnings Valuation Method

Following that, the capitalization of the earnings valuation approach forecasts a company's future profitability based on cash flow, yearly ROI, and predicted value.

Unlike the DCF method, this strategy works best for stable businesses because the formula assumes that computations for a specific time period would continue.

5. Multiples of Earnings Valuation Method

The multiple of earnings valuation approach, like the capitalization of earnings valuation method, evaluates the value of a corporation by its future profits potential.

Having said that, this small business valuation method, also called the time revenue method, determines a company's maximum worth by multiplying its current sales by a factor. Multipliers differ depending on the industry, the economic climate, and other considerations.

Wrapping it up

Business valuation is complicated—especially when you examine the various ways available to appraise your company and estimate its economic worth.

Overall, it's safe to state that one strategy isn't necessarily superior to another; instead, the best estimate of your firm will most likely arise from integrating numerous business valuation methodologies.

This being said, if you do require a small business valuation, your best bet will be to employ a professional appraiser—as previously noted, this expert will be able to provide the most thorough and objective evaluation of your firm.

Arrowfish Consulting is the place to go if you are a busy attorney in San Diego looking for a damages expert to meet a tight deadline, a business owner in Dallas looking for a business valuation, or a manufacturing company in Denver looking for a dependable business interruption loss analysis.

We will provide you with the highest level of professional service at competitive rates that are tailored to your specific requirements.