Approaches to business valuation
The asset-based approach to business valuation
Some call this approach ‘the cost approach to business valuation.”
This approach is only valid on its own for non-operating companies. For operating companies, it must combine with either, or both of, the other approaches.
The methods in this approach include
There is a some more to learn about the asset approach to business valuation here.
The market approach to business valuation
This limted approach has accuracy issues. It may appear to include some excellent and reliable methods, but be careful.
In no particular order of frailty they include:
There are obvious limitations comparing a listed public company to a private one:
Industry-wide guidelines are akin to socialist command economy directives. Sure,it makes for easy succession or retirement planning. But what if your business is better than a product of a "generally accepted multiplier"?
Like industry guidelines, rules of thumb are a recipe for value to price inequity.
Using contemporary business comparisons is an unrealistic ideal. No matter what anybody tells you, there is no sample size of any relevance.
We have more to say about the market approach to business valuation here.
The income approach to business valuation
The methods in which fall under this approach are either based on
They take known performance in a current or recent period. Then in simple formulas, they compute "a value". The formulas will fall into the following methods
These methods are easy to use and re-use. Their limitation is in knowing the multiplier, weighting, or capitalisation rate to use.
The weakness is in projecting future cash flows. That is dealth with using appropriate discounts for risk.
Each of these include risk discounts for the business, the industry, and the country. Sellers should avoid their use in pitches to buyers.
Having said that, buyers and investors prefer the projection-based methods. They give results for justifying holding or acquiring assets.
We unpack much more about the income approach to business valuation here.