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What is a business valuation? It sounds like a straightforward question, right? A business valuation comprises several different – and critical – pieces that come together to assess a business’s total value and are especially crucial when you are planning to sell a business. A proper business valuation is made up of three different calculations, known as approaches.  The results of each approach are analyzed independently and constructively when determining a final value for a business. Let’s discuss these approaches, what they mean and how they impact a valuation.  

Asset-Based Approach:

The asset-based approach, sometimes referred to as the cost approach, focuses on assets rather than income or market values. During this calculation, each business component is valued separately and summed up to attain the total value of the enterprise. An appraiser will estimate value by taking the cost of duplicating or replacing the individual elements of the business property, item by item, and asset by asset. Only the tangible assets of the business are valued in this estimate calculation. Tangible assets are assets that your business’s core operations are dependent on to run operations. Intangible assets – which many businesses have – are not accounted for during this analysis because they are typically non-physical assets with a monetary value. Examples could be patents, copyrights, or your company’s brand, and these particular assets cannot be used alone to provide an accurate and holistic picture of a business’s value.  

Income Approach:

The income approach, sometimes referred to as the investment value approach, focuses on income instead of market value. This approach assumes that an investor could invest in a business with similar investment characteristics, although not necessarily the same. Since estimating the future income of a business can be speculative, historical data is generally used as a starting point for reference under the premise history will likely repeat itself. The estimation of this approach generally determines the value of the business as if it is equal to the present value of the future benefit stream to the owners. This is accomplished by either capitalizing on a single-period income stream or discounting a series of income streams based on a multi-period forecast.  

Market Approach: 

The market approach is fundamental to business valuations as the market determines fair market value. Under this approach, the appraiser attempts to find guideline companies traded on a public stock exchange in the same or similar industry as the appraisal subject. That allows a comparison between the pricing multiples, the public company trades at, and the multiple deemed appropriate for the appraisal subject. Another common variation of this approach is to locate entire companies that have been bought and sold in the marketplace, publicly traded, or closely held, that allow the appraiser to determine the multiples that resulted from the transactions. These multiples can then be applied, with or without adjustment to the appraisal subject.

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Residing within each approach lies a tremendous amount of research. Separate asset and real estate appraisals, SEC filing reviews, private sale database cleansing, normalization adjustments, discount rate build-ups, and control/marketability premiums or discounts are all considered. Therefore, choosing an expert that understands each of the three approaches and the vital underlying work that permits for an accurate and defendable conclusion is critical for an accurate business valuation, you can count on! Maner is here to be that expert and help you understand where your business stands, understand the analysis and help in identifying your next steps. For more questions, please contact Jeff Allen, CPA, ABV, Principal, at jallen@manercpa.com or maner@manercpa.com!