The 3 Approaches to Business Valuation
What is your business worth? In reality, this question is quite subjective. There is no one way to establish the worth of a business because business value can mean different things to different people. For instance, you might think that your company’s connection to the community is worth a lot while your investors feel that the value of your business is based entirely on income. The value of your business can change from one moment to the next depending on a variety of different factors related to the economy and other social aspects of the community in which you are established.
Business valuation is a process that determines what a business is worth in financial terms; it is largely an economic analysis exercise. There are two things you must do before you can establish the value of your company. First, you must determine why you need a valuation, and then you must assemble all of the required information.
The two primary financial statements you need to conduct a business valuation report are the income statement and the balance sheet. To do a proper business valuation analysis, you should be able to produce three to five years of historic income statements and balance data.
There are three approaches to business valuation: comparison to recent sales by similar establishments, analysis of the business earning power and risk assessment, and the approach that looks at the company’s assets.
The Three Approaches to Business Valuation
Valuation Market Approach: The market approach asks the question: What are similar businesses worth? Take a look at the other businesses within your market and basically find out what the “going rate” is for your business type.
Valuation Income Approach: Look at the potential economic benefits of your business. What is your expected income? What level of risk are you facing?
Valuation Asset Approach: This approach addresses the question: How much would it cost to create another business like this one that will produce the same benefits? Figure out which assets and liabilities to include in the valuation and determine what each is worth.
Remember, circumstances change, so your business valuation will not produce absolute results.