Ultimately, a company’s value is the amount a buyer is willing to pay for it. But, a business valuation is the starting point to determine a business’ economic value.
A qualified business valuation professional can help establish value by using rigorous industry standards and applying various valuation approaches.
The three main methods used to determine a company’s value are the asset approach, the income approach, and the market approach.
Asset approach
The asset approach is a mathematical calculation that starts with the current fair market value of assets, then subtracts the fair market value of liabilities. This approach is also known as the cost approach, the adjusted net asset value method, or the adjusted book value method.
Your valuation expert should include both tangible and intangible assets in his/her calculation.
Tangible assets are physical assets like machinery, buildings, land, and inventory.
Intangible assets are nonphysical assets including patents, trademarks, copyrights, goodwill, and brand. Calculating their value is somewhat subjective.
Business owners may overestimate their value while buyers may question their worth. The value of intangible assets is often scrutinized during negotiations and the due diligence process because it’s challenging to agree on the numbers.
Income approach
The income approach values a business based on its potential future cash flow. Common methods for this calculation are the capitalization of earnings method and the discounted cash flow (DCF) method.
The income approach relies on using a number of assumptions about the existing business and its future cash flow potential.
The seller and the buyer must agree upon these assumptions as the deal is negotiated.
Market approach
The market approach determines the value of a company based on the sales of similar companies. This is based on either public or private information.
The challenge with this approach is finding true comparables. Your valuation professional may need to adjust certain factors to obtain an accurate appraisal. These factors may include company size, profitability, growth, and leverage.
Should I sell now or build value?
Regardless of the valuation method used, sellers may be disappointed when the valuation process delivers a value that’s lower than expected.
But there’s a silver lining. If you’re not happy with the estimated value of your business, you can delay the sale and take steps to increase its value.
Your valuation professional can help you develop an action plan to focus your energy where it’ll have the largest return on investment. This allows you to increase the value of your business over months or years before moving forward with a sale.
Have questions about your company’s value? Let’s talk!
