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The income approach to business valuation

For the most part, operating companies and businesses are best served using an income approach to business valuation. There are many models and methods which fall under this grouping. For the most part they fall into one of two categories, either based on

  •   historic income statement items, or
  •   expected or projected future cash flow

History-based methods

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

  • simple multiplier formulas
  • weighted average multipliers
  • capitalised owner benefit

These methods are easy to use and re-use. Their limitation is in knowing the multiplier, weighting, or capitalisation rate to use.

Projection-based methods

The weakness is in projecting future cash flows. That is dealth with using appropriate discounts for risk.

  • discounted cash flow,
  • adjusted present value
  • discounted dividend flow, and
  • internal rate of return regression
  • forward-looking multiple models
  • its risk profile,
  • the capital structure, and
  • its industry and peer performance comparison.

Having said that, buyers and investors prefer the projection-based methods. They give results for justifying holding or acquiring assets.

While history based models are easy for small and medium size business valuations, independent investors prefer the forward-looking projection-based models.

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