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How to Value a Company: 6 Methods and Examples

• 21 Apr 2017

Determining a company's fair market value is an essential finance skill for business leaders aiming to succeed in today’s dynamic marketplace. So, how do finance professionals evaluate assets to identify one number when determining how to value a company?

Whether you're planning to buy, sell, or simply enhance your business's strategic planning , understanding valuation is key to navigating the financial landscape with confidence.

Below is an exploration of some common financial terms and financial valuation techniques used to value businesses and why some companies might be valued highly despite being relatively small.

Access your resource today.

What Is Company Valuation?

Company valuation , also known as business valuation, is the process of assessing the total economic value of a business and its assets. During this process, all aspects of a business are evaluated to determine the current worth of an organization or department. The valuation process occurs for various reasons, such as determining sale value and tax reporting.

How to Valuate a Business

One way to calculate a business’s valuation is to subtract liabilities from assets. However, this simple method doesn’t always provide the full picture of a company’s value. This is why several other methods exist.

Here’s a glimpse at six business valuation methods that provide insight into a company’s financial standing, including book value, discounted cash flow analysis, market capitalization, enterprise value, earnings, and the present value of a growing perpetuity formula.

1. Book Value

One of the most straightforward methods of valuing a company is to calculate its book value using information from its balance sheet . Yet, due to the simplicity of this method, it’s notably unreliable.

Related: Check out our video on the balance sheet below, and subscribe to our YouTube channel for more explainer content!

To calculate book value, start by subtracting the company’s liabilities from its assets to determine owners’ equity. Then, exclude any intangible assets. The figure you’re left with represents the value of any tangible assets the company owns.

As Harvard Business School Professor Mihir Desai mentions in the online course Leading with Finance , balance sheet figures can’t be equated with value due to historical cost accounting and the principle of conservatism. Relying on basic accounting metrics doesn't accurately represent a business’s true value.

2. Discounted Cash Flows

Another method of valuing a company is with discounted cash flows. This technique is highlighted in Leading with Finance as the gold standard of valuation.

Discounted cash flow analysis is the process of estimating the value of a company or investment based on the money, or cash flows, it’s expected to generate in the future . Discounted cash flow analysis calculates the present value of future cash flows based on the discount rate and time period of analysis.

Discounted Cash Flow =

Terminal Cash Flow / (1 + Cost of Capital) # of Years in the Future

The benefit of discounted cash flow analysis is that it reflects a company’s ability to generate liquid assets. The challenge of this type of valuation, however, is that its accuracy relies on the terminal value, which can vary depending on the assumptions you make about future growth and discount rates.

3. Market Capitalization

Market capitalization is one of the simplest measures of a publicly traded company's value. It’s calculated by multiplying the total number of shares by the current share price .

Market Capitalization = Share Price x Total Number of Shares

One of the shortcomings of market capitalization is that it only accounts for the value of equity, while most companies are financed by a combination of debt and equity.

In this case, debt represents investments by banks or bond investors in the company's future; these liabilities are paid back with interest over time. Equity represents shareholders who own stock in the company and hold a claim to future profits.

Let's review enterprise values—a more accurate measure of company value that considers these differing capital structures.

4. Enterprise Value

The enterprise value is calculated by combining a company's debt and equity and then subtracting the cash amount not used to fund business operations.

Enterprise Value = Debt + Equity - Cash

To illustrate this, let’s explore three well-known car manufacturers: Tesla, Ford, and General Motors (GM).

In 2016, Tesla had a market capitalization of $50.5 billion. On top of that, its balance sheet showed liabilities of $17.5 billion. The company also had around $3.5 billion in cash in its accounts, giving Tesla an enterprise value of approximately $64.5 billion.

Ford had a market capitalization of $44.8 billion, outstanding liabilities of $208.7 billion, and a cash balance of $15.9 billion, leaving an enterprise value of approximately $237.6 billion.

Lastly, GM had a market capitalization of $51 billion, balance sheet liabilities of $177.8 billion, and a cash balance of $13 billion, leaving an enterprise value of approximately $215.8 billion.

While Tesla's market capitalization is higher than Ford and GM, Tesla is also financed more from equity. In fact, 74 percent of Tesla’s assets have been financed with equity, while Ford and GM have capital structures that rely much more on debt. Nearly 18 percent of Ford's assets are financed with equity and 22.3 percent of GM's.

When examining earnings, financial analysts don't like to look at a company's raw net income profitability. It’s often manipulated in a lot of ways by the conventions of accounting, and some can even distort the true picture.

To start with, the tax policies of a country seem like a distraction from the actual success of a company. They can vary across countries or time, even if nothing changes in the company’s operational capabilities. Second, net income subtracts interest payments to debt holders, which can make organizations look more or less successful based solely on their capital structures. Given these considerations, both are added back to arrive at EBIT (Earnings Before Interest and Taxes) or “ operating earnings .”

In normal accounting, if a company purchases equipment or a building, it doesn't record that transaction all at once. The business instead charges itself an expense called depreciation over time. Amortization is the same as depreciation but for things like patents and intellectual property. In both instances, no actual money is spent on the expense.

In some ways, depreciation and amortization can make the earnings of a rapidly growing company look worse than a declining one. Behemoth brands, like Amazon and Tesla, are more susceptible to this distortion since they own several warehouses and factories that depreciate in value over time.

Understanding how to arrive at EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for each company makes it easier to explore ratios.

According to the Capital IQ database , Tesla had an Enterprise Value to EBITDA ratio of 36x. Ford's is 15x, and GM's is 6x. But what do these ratios mean?

6. Present Value of a Growing Perpetuity Formula

One way to think about these ratios is as part of the growing perpetuity equation. A growing perpetuity is a financial instrument that pays out a certain amount of money each year—which also grows annually. Imagine a stipend for retirement that needs to grow every year to match inflation. The growing perpetuity equation enables you to find today’s value for that financial instrument.

The value of a growing perpetuity is calculated by dividing cash flow by the cost of capital minus the growth rate.

Value of a Growing Perpetuity = Cash Flow / (Cost of Capital - Growth Rate)

So, if someone planning to retire wanted to receive $30,000 annually, forever, with a discount rate of 10 percent and an annual growth rate of two percent to cover expected inflation, they would need $375,000—the present value of that arrangement.

What does this have to do with companies? Imagine the EBITDA of a company as a growing perpetuity paid out every year to the organization’s capital holders. If a company can be thought of as a stream of cash flows that grow annually, and you know the discount rate (the company’s cost of capital), you can use this equation to quickly determine the company’s enterprise value.

To do this, you’ll need some algebra to convert your ratios. For example, if you take Tesla with an enterprise-to-EBITDA ratio of 36x, that means the enterprise value of Tesla is 36 times higher than its EBITDA.

If you look at the growing perpetuity formula and use EBITDA as the cash flow and enterprise value as what you’re trying to solve for in this equation, then you know that whatever you’re dividing EBITDA by is going to give you an answer that is 36 times the numerator.

To find the enterprise value to EBITDA ratio, use this formula: enterprise value equals EBITDA divided by one over ratio. Plug in the enterprise value and EBITDA values to solve for the ratio.

Enterprise Value to EBITDA Ratio = EBITDA / (1 / Ratio)

In other words, the denominator needs to be one thirty-sixth or 2.8 percent. If you repeat this example with Ford, you'd find a denominator of one-fifteenth or 6.7 percent. For GM, it would be one-sixth or 16.7 percent.

Plugging it back into the original equation, the percentage equals the cost of capital. You could then imagine that Tesla might have a cost of capital of 20 percent and a growth rate of 17.2 percent.

The ratio doesn't tell you exactly, but one thing it highlights is that the market believes Tesla's future growth rate will be close to its cost of capital. Tesla's first-quarter sales were 69 percent higher than this time last year.

Leveraging Growth for Higher Company Valuation

In finance, growth is powerful. It explains why a smaller company like Tesla carries a high enterprise value. The market has taken notice that, while Tesla is much smaller today than Ford or GM in total enterprise value and revenues, that may not always be the case.

Growth not only measures a company’s current achievements but predicts its future potential. Companies viewed as growth leaders attract investors willing to pay a premium for the promise of future returns. This is especially true in industries where innovation leads to market disruption .

Moreover, prioritizing growth drives companies to innovate and expand, setting the stage for long-term success. Understanding this trajectory is vital for leaders and investors, as it goes beyond current financials to envision future potential.

This forward-looking approach sets market leaders apart, allowing them to strengthen their position and reshape their industries through growth.

If you want to advance your understanding of financial concepts like company valuation, explore our six-week online course Leading with Finance and other finance and accounting courses to discover how you can develop the intuition to make better financial decisions. Not sure which course is right for you? Download our free flowchart to find out.

This post was updated on August 23, 2024. It was originally published on April 21, 2017.

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Here's How to Value a Company [With Examples]

Published: May 24, 2023

What's your company worth? It's an important question for any entrepreneur , business owner , or potential investor.

What's more, knowing how to value your business becomes increasingly important as it grows, especially if you want to raise capital, sell a portion of the business, or borrow money. 

Here, we'll take a look at different factors to consider when valuing your business, common equations you can use, and high-quality tools that will help you crunch the numbers.

Table of Contents

How to value a business.

Public vs. Private Valuations

Business Valuation Methods

Business Valuation Calculators

Company valuation example, what is a business valuation.

As the name suggests, a business valuation determines the value of a business or company. During the process, all areas of a business are carefully analyzed, including its financial performance, assets and liabilities, market position, and future growth potential.

Ultimately, the goal is to arrive at a fair and objective estimate which can be useful in making business decisions and negotiating.

• Company Size
• Profitability
• Market Traction and Growth Rate
• Sustainable Competitive Advantage
• Future Growth Potential

1. Company Size

Company size is a commonly used factor when valuing a company. Typically, the larger the business, the higher the valuation will be. This is because smaller companies have little market power and are more negatively impacted by the loss of key leaders. In addition, larger businesses likely have a well-developed product or service and, as a result, more accessible capital.

2. Profitability

Is your company earning a profit?

If so, this a good sign, as businesses with higher profit margins will be valued higher than those with low margins or profit loss. The primary strategy for valuing your business based on profitability is through understanding your sales and revenue data. 

Valuing a Company Based On Sales and Revenue

Valuing a business based on sales and revenue uses your totals before subtracting operating expenses and multiplying that number by an industry multiple. Your industry multiple is an average of what businesses typically sell for in your industry so, if your multiple is two, companies usually sell for 2x their annual sales and revenue.

3. Market Traction and Growth Rate

When valuing a company based on market traction and growth rate, your business is compared to your competitors. Investors want to know how large your industry market share is, how much of it you control, and how quickly you can capture a percentage of the market. The quicker you reach the market, the higher your business’ valuation will be.

4. Sustainable Competitive Advantage

What sets your product, service, or solution apart from competitors? 

With this method, the way you provide value to customers needs to differentiate you from the competition. If this competitive advantage is too difficult to maintain over time, this could negatively impact your business' valuation. 

A sustainable competitive advantage helps your business build and maintain an edge over competitors or copycats in the future, pricing you higher than your competitors because you have something unique to offer.

5. Future Growth Potential

Is your market or industry expected to grow? Or is there an opportunity to expand the business' product line in the future? Factors like these will boost the valuation of your business. If investors know your business will grow in the future, the company valuation will be higher. 

The financial industry is built on trying to accurately define current growth potential and future valuation. All the characteristics listed above have to be considered, but the key to understanding future value is determining which factors weigh more heavily than others.

Depending on your type of business, there are different metrics used to value public and private companies.

Public Versus Private Valuation

Public Company Valuation

For public companies, valuation is referred to as market capitalization (which we’ll discuss below) — where the value of the company equals the total number of outstanding shares multiplied by the price of the shares.

Public companies can also trade on book value, which is the total amount of assets minus liabilities on your company balance sheet. The value is based on the asset’s original cost less any depreciation, amortization, or impairment costs made against the asset.

Private Company Valuation

Private companies are often harder to value because there's less public information, a limited track record of performance, and financial results are either unavailable or might not be audited for accuracy.

Let's take a look at the valuations of companies in three stages of entrepreneurial growth.

1. Ideation Stage

Startups in the ideation stage are companies with an idea, a business plan, or a concept of how to gain customers, but they're in the early stages of implementing a process. Without any financial results, the valuation is based on either the track record of the founders or the level of innovation that potential investors see in the idea.

A startup without a financial track record is valued at an amount that can be negotiated. Most startups I've reviewed created by a first-time entrepreneur start with a valuation between $1.5 and $6 million.

All the value is based on the expectation of future growth. It's not always in the entrepreneur’s best interest to maximize its value at this stage if the goal is to have multiple funding rounds. The valuation of early-stage companies can be challenging due to these factors.

2. Proof of Concept

Next is the proof of concept stage. This is when a company has a handful of employees and actual operating results. At this stage, the rate of sustainable growth becomes the most crucial factor in valuation. Execution of the business process is proven, and comparisons are easier because of available financial information.

Companies that reach this stage are either valued based on their revenue growth rate or the rest of the industry. Additional factors are comparing peer performance and how well the business is executing in comparison to its plan. Depending on the company and the industry, the company will trade as a multiple of revenue or EBITDA (earnings before interest, taxed, depreciation, and amortization).

3. Proof of Business Model

The third stage of startup valuation is the proof of the business model. This is when a company has proven its concept and begins scaling because it has a sustainable business model.

At this point, the company has several years of actual financial results, one or more products shipping, statistics on how well the products are selling, and product retention numbers.

Depending on your company, there are a variety of equations to use to value your business.

Company Valuation Methods

Let’s take a look at some of the formulas for business valuation. 

Market Capitalization Formula

Market Value Capitalization is a measure of a company’s value based on stock price and shares outstanding. Here is the formula you would use based on your business’ specific numbers: 

Multiplier Method Formula

You would use this method if you’re hoping to value your business based on specific figures like revenue and sales. Here is the formula: 

Discounted Cash Flow Method

Discounted Cash Flow (DCF) is a valuation technique based on future growth potential. This strategy predicts how much return can come from an investment in your company. It is the most complicated mathematical formula on this list, as there are many variables required. Here is the formula: 

Image Source

Here are what the variables mean: 

• CF = Cash flow during a given year (can include as many years as you’d like, simply follow the same structure).
• r = discount rate, sometimes referred to as weighted average cost of capital ( WACC ). This is the rate that a business expects to pay for its assets.

This method, along with others on this list, requires accurate math calculations. To ensure you’re on the right track, it may be helpful to use a calculator tool. Below we’ll recommend some high-quality options. 

Below are business valuation calculators you can use to estimate your companies value.

This calculator looks at your business' current earnings and expected future earnings to determine a valuation. Other business elements the calculator considers are the levels of risk involved (e.g., business, financial, and industry risk) and how marketable the company is.

2. EquityNet

EquityNet's business valuation calculator looks at various factors to create an estimate of your business’s value. These factors include:

• Odds of the business' survival
• Industry the business operates in
• Assets and liabilities
• Predicted future revenue
• Estimated profit or loss

3. ExitAdviser

ExitAdviser's calculator uses the discounted cash flow (DCF) method to determine a business’s value. To determine the valuation, "it takes the expected future cash flows and ‘discounts' them back to the present day.”

It may be helpful to have an example of company valuation, so we’ll go over one using the market capitalization formula displayed below: 

Shares Outstanding x Current Stock Price = Market Capitalization

For this equation, I need to know my business’s current stock price and the number of outstanding shares. Here are some sample numbers: 

Shares Outstanding: $250,000

Current Stock Price: $11

Here is what my formula would look like when I plug in the numbers:

250,000 x 11 

Based on my calculations, my company’s market value is 2,750,000.

Back to You

Whether you’re looking to borrow money, sell a portion of your company, or simply understand your market value, understanding how much your business is worth is important for your business’ growth.

Don't forget to share this post!

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How To Do a Business Valuation? 5 Methods With Examples

In this post

Why do you need a business valuation?

5 business valuation methods, which business valuation method is right for you.

Let’s avoid another WeWork fiasco, shall we?

The popular coworking company cuts its once $47 billion valuation to just $10 billion, removed its CEO, and delayed its IPO indefinitely. Yikes. 

What happened? Essentially, the venture capitalists were shooting for the moon. No,  really, one of the initial WeWork ideas was to put office space on Mars. 

While there are several business valuation methods, spreadsheet software can be used to organize, catalog, and maintain data in an easy-to-understand manner for real-time collaboration and analysis. Spreadsheet tools can be helpful in the calculation and analysis of business valuation. 

What is a business valuation?

Business valuation is the result of the process and procedures used in estimating what a business is worth or its economic value. A business’s value isn’t always straightforward, and in order to get the right business valuation, you have to conduct a considerable amount of research on the company itself and its current market.

Let’s discuss how business valuations work and the different methods you can use.

Depending on factors such as the size of the business or industry, the preferred business valuation model will differ. The process can be complex and involves several calculations. But why do we need a business valuation in the first place?

• Tax purposes 
• When you wish to sell your business
• If you choose to add shareholders
• While looking for business investors or financial advisors
• If you wish to merge or acquire a business
• While establishing partnership and ownership

Want to learn more about Spreadsheets Software? Explore Spreadsheets products.

There are five main ways to value your business: asset approach, income approach, market approach, return on investment (ROI) approach, and discounted cash flow approach . 

1. Asset approach

The asset approach essentially totals up all of the investments in the business. With this business valuation, you see a business as being made up of only assets and liabilities . 

Basically, the contents of your balance sheet create the foundation for the value of your business. 

• Going-concern asset-based approach: Takes the business’s net balance sheet sum of assets and subtracts the sum of its liabilities.
• Liquidation asset-based approach: Evaluates the net amount that would be received if all assets were sold and liabilities were paid off.

The asset-based valuation method works well for corporations since the assets are owned by the company itself and are also included in sales. This approach can be difficult for sole proprietors as it can be quite difficult to separate personal and business assets. Let’s take an example in which a sole proprietor wants to sell their company; a prospective buyer would have to sort through assets to determine which assets belong to the owner and which to the business. 

Both of these methods require a strong understanding of a business’s current standing and balance sheet. In short, this business valuation method is like asking, “What will it cost to build an identical business?”

Tip: Get your balance sheet in order with this free template! 

2. Market approach

When valuing a business with the market approach, you look to the external marketplace. In other words, “What are other businesses that are competitive or similar to mine worth?” 

Similar to buying a house, you have to look at comps and evaluate the worth from there. This valuation method is not always an option if you’re creating a category, as it only works if there’s enough to compare it against.

The ‘going rate’ is known as fair market value – a value exchanged between a buyer and a seller that is agreeable and mutually beneficial to both parties. 

For example, your business assets are worth $4 million. If a similar company is being sold in the $3.5 million range, you may end up losing money on the sale. The market approach might be popular, but evaluating whether it’s the right approach for your business is key to doing the right business valuation. 

3. Income approach

The income approach, also known as the earning value approach, relies heavily on the probability of the business being profitable in the future. 

What’s most important when valuing a business? Return on investment (ROI)! This business valuation method puts ROI front and center, basing the numbers off of what someone can expect to make on their investment.

• Capitalizing past earnings: Projects the company’s potential profits based on its past earnings, adjusting them for unusual or one-off expenses or revenue, and then multiplying by a capitalization factor.
• Discounted future earnings: Determines the value by averaging the trend of predicted future earnings and then dividing that by the capitalization factor.

The capitalization factor largely depends on the earnings history of the business. It can typically range anywhere from 12% for an established business to 50% for an unproven business in a volatile market. 

If your business shows steady profit growth year over year, the capitalization method based on past earnings is the way to go. If you are a rapidly changing startup, the best bet for your business valuation would be discounting future earnings. 

To calculate the business value with the help of capitalizing past earning method under the income method, we can use the following formula.

Business Value = Annual Future Earnings/Required Rate of Return

For example, if a real-estate company named ABC has a forecasted earning of $19 million and the required rate of return is 12%, the business valuation would be $19 million/12% = $158.33 million.

4. Return on Investment (ROI) approach

The return on investment (ROI) approach allows you to value the business based on the profitability and the ROI that an investor can potentially receive if they buy into the business.

Let’s understand this with the help of an example. You pitch the business to investors and ask for $250,000 in exchange for 25% of your business. Divide the amount by the percentage offered, $250,000/0.25 = 1 million. 

This method makes sense from investors' perspective since they would know what to expect as their ROI. However, the valuation ultimately depends on the market. An investor may want to know how long it takes to recover the original investment, the expected net income, etc. 

5. Discounted cash flow (DCF) approach

Discounted cash flow approach (DCF) approach values a business based on the projected cash flow adjusted to its present value. It can be particularly useful when profits are not projected to remain constant in the future. This method requires careful calculations. 

The formula used to calculate DCF is as follows: 

DCF = Terminal Cash Flow / (1 + Cost of Capital) 

Analyzing the DCF shows the company's ability to generate liquid assets. However, one of the challenges faced would be the accuracy of the terminal value, which may vary based on the assumptions about discount rates or growth of the company.  Let's understand this better with the help of an example.

There is an investment opportunity that may produce $100 per year at a discount rate of 10%. To calculate the present value and the stream of future cash flows, we must reduce the present value of each cash flow by 10%. The cash flow for the first year is $90.91, the second year is $82.64, and the third year is $75.13. Adding these cash flows gives us the DCF of the investment as $248.68. 

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Choosing the right business valuation method is crucial. While you might want to try them all and compare your findings, most businesses use a combination of methods to find a true value. There are a few things to keep in mind before you start crunching some numbers. 

Every business is different, and what works for one, even a similar one, won’t necessarily be the right business valuation method for yours. That means that what you’ve used to evaluate past businesses might not be the right one you should use for this new venture. 

Also, you might not be the best person to evaluate your own business. You’re too close to it and bound to inflate a few numbers here and there based on hopes and wishes, thus throwing the whole projection off. A business valuation needs to be objective to be right. 

Determine your business's worth 

No matter the size of your business, a business valuation must be done at some point – maybe multiple times and in multiple ways. This is an extremely flexible process, which makes it even more difficult. However, choosing the right business valuation method will help determine how much the business is worth and help make the right strategic decisions to aid growth. 

Investing and managing your business assets can be scary. Learn more about asset management and why it's important for your business before you make your next big move!

Bridget Poetker

Bridget Poetker is a former content team lead at G2. Born and raised in Chicagoland, she graduated from U of I. In her free time, you'll find Bridget in the bleachers at Wrigley Field or posted up at the nearest rooftop patio. (she/her/hers)

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How to Value a Small Business if You’re Looking to Sell

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A small-business valuation represents a company’s total worth based on its business assets, earnings, industry and any debt or losses. Conducting a valuation is an excellent opportunity to assess the financial health and potential of your business, or of a business you’re hoping to buy .

Whether you are planning to sell your business or you already have an offer, knowing how to value a business can help inform your company’s road map and future exit strategies. Entrepreneurs looking to buy an existing business should also be familiar with valuations and feel comfortable estimating value independently of the business owner or broker’s asking price.

How to value a small business

There are some key steps to begin valuing your business. In addition to doing your own research, consider consulting a professional.

1. Understand the terms

Unless you’re a natural-born business or numbers person (or, say, an accountant), business valuation isn’t the easiest process. You'll need to understand some key definitions first.

Seller’s discretionary earnings

Seller’s discretionary earnings (SDE) represents the total financial value that a single owner would get from owning a business on an annual basis. Also referred to as adjusted cash flow, total owner’s benefit, seller’s discretionary cash flow or recast earnings, the calculation includes expenses like the income you report to the IRS, noncash expenses. It essentially represents whatever revenue your business actually generates.

SDE vs. EBITDA

Different from earnings before interest, taxes, depreciation and amortization (EBITDA), SDE also includes the owner’s salary and owner’s benefits. Large businesses generally use EBITDA calculations to value their businesses, and small businesses typically use SDE, since small-business owners often expense personal benefits.

SDE multiple

Your SDE multiple values your business according to industry standards — there is a different multiple for every industry. Your SDE multiple will vary based on market volatility, where your business is located, your company’s size, assets and how much risk is involved in transferring ownership.

The higher your SDE multiple, as you might expect, the more your business is worth. If you used EBITDA to value your business, you would use an EBITDA multiple.

SDE calculation

To calculate your business’s SDE:

Step 1: Find your pretax, pre-interest earnings.

Step 2: Add back purchases that aren’t essential to operations, like vehicles or travel, that you report as business expenses. Employee outings, charitable donations, one-time purchases and your own salary can all be included in your SDE. (Buyers might ask about your discretionary cash flow when you offer them your valuation, so be prepared to include and value each major expense or purchase.)

Step 3: Subtract any current debts or future payments from the net income.

Step 4: Compare with your SDE multiple.

How much do you need?

with Fundera by NerdWallet

We’ll start with a brief questionnaire to better understand the unique needs of your business.

Once we uncover your personalized matches, our team will consult you on the process moving forward.

2. Organize your documents

To ensure an accurate calculation, sellers and buyers should have organized financial records, which will also be crucial for the actual transfer of ownership.

Business owners need the following documentation in order to ensure a smooth valuation process:

Licenses, deeds and any proprietary documents.

Profit and loss statements and balance sheets for the last three years.

Tax filings and returns.

Short overview of your business or personal finances.

While buyers won't need all of these documents, they should still review their own financials. It's likely that sellers will want to see the credit report and basic financial profile of the individual or business they are selling to.

» MORE: Best small-business accounting software

In addition to financial records, buyers may want to see a business plan , which can help make accurate projections for earnings, how your business will continue to grow and turn a profit, provide important context about your company and detail your key services or goods. It should also detail your business model , which demonstrates how you make money, and shows potential buyers how they’ll actually reach their customer base to generate revenue if they purchase your company.

3. Take stock of your assets and liabilities

Assets and liabilities are an important factor in a business’s overall value, and they’re important to know in detail for both sellers and buyers. Business assets are anything that adds value to your company, such as intellectual property, your production line or company vehicles.

There are two types of assets — tangible and intangible assets — and they’re weighted differently when calculating a business’s total value. Tangible assets are physical assets that are used for regular business operations and lose value over time. They include things like real estate, equipment, inventory and cash on hand.

Intangible assets are things that hold value, but cannot be seen or touched. They include things like patents, copyrights or trademarks, customer loyalty, reputation and intellectual property. Intangible assets are also things that cannot be separated from the company itself.

Liabilities are generally outstanding obligations that detract from the overall value of a business. They include accounts and notes payable, business loans , accrued expenses and unearned revenue. Business owners often keep their business liabilities and pay off their debt after the business is sold.

» MORE: What is a business debt schedule?

4. Research your industry

A deep understanding of your industry’s trends can help both buyers and sellers reach an informed valuation that reflects a business’s assets as well as the current market. Understanding the industry helps:

Determine the SDE multiple as well as the method of valuation used. 

Assess market share and growth potential. 

See what comparable businesses are selling for. 

LLC Formation

Small-business valuation methods

There are several business valuation methods. Each uses a different aspect or variable of a business to calculate its numerical value — either a business’s income, assets or using market data on similar companies. Your ultimate valuation should be the result of consistent calculations, not a mix and match of formulas or approaches.

Income approach

The income approach to business valuation determines the amount of income a business can expect to generate in the future. If you want to take the income approach, you can choose between two commonly used valuation methods.

Discounted cash flow method : This method determines the present value of a business's future cash flow . The business's cash flow forecast is adjusted (or discounted) according to the risk involved in purchasing the business. This approach works best for newer businesses that have high-growth potential, but aren’t yet profitable.

Capitalization of earnings method : The capitalization of earnings method also calculates a business’s future profitability, taking into account the business’s cash flow, annual rate of return (or return on investment), and its expected value. But where the discounted cash flow method accounts for more fluctuations in a business's financial future, the capitalization method assumes that calculations for a single period of time will continue in the future. So, established businesses with stable profitability often use this valuation approach.

Most online business valuation calculators use a variation of the income approach. But if you have more financial information on hand, you can try a more comprehensive business valuation tool that includes both profit and revenue, as well as assets and liability, in the calculation.

Asset-driven approach

Another common method attributes value to a business based solely on its assets. In particular, the Adjusted Net Asset Method calculates the difference between a business's assets — including equipment, property and inventory, and intangible assets—and its liabilities, both of which are adjusted to their fair market values. Asset valuations are also a great tool for internal use and can help you keep track of spending and capital resources.

To do an asset-driven assessment, you’ll make a list of your assets and assign them a monetary value. For equipment or other depreciating assets, that value is usually somewhere between the sale price and the depreciated value. A good rule of thumb is to estimate how much a piece of equipment would sell for today, and use that number.

Because you’re familiar with your own equipment and production, you can make pretty accurate estimates of each of your asset’s value and depreciation. Even if you don't adjust the asset's worth according to the current market, you can still get a good sense of a business’s material value. This method is especially useful if your business mostly holds investments or real estate, isn’t profitable, or if you’re seeking to liquidate. In any of those cases, buyers will be interested in the individual value of your investments or equipment.

Market approach

As you can deduce from its name, the market approach to valuing a business determines a company’s value based on the purchases and sales of comparable companies within the same industry. This approach will specifically help you determine an appropriate selling or purchase price based on your local market. Any business can use this approach to business valuation, as long as it can gather sufficient, relevant data on which to compare their business. It can be an especially useful approach for rapidly growing businesses and industries.

On a similar note...

9 Business Valuation Methods: What's Your Company's Value?

Table of contents

This post was originally published in April 2022 and has been updated for relevancy on May 7, 2024.

Whether you’re on the buy-side or sell-side , having an accurate valuation of your business is an essential part of extracting value from a transaction. Those that are better able to value assets are the most successful investors of all time. And while you can add value to a transaction through a successful integration , paying the right price for a company gives you the best platform to do so.

What is Business Valuation?

Company Valuation or Business Valuation, is the process by which the economic value of a business, whether a large or small business is calculated. The purpose of knowing the business’s value is to find the intrinsic value of the entire company - its value from an objective perspective. Valuations are mostly used by investors, business owners, and intermediaries such as investment bankers, who are seeking to accurately value the company’s equity for some form of investment.

Although business valuations are mostly used to value a company’s equity for some form of investment, it isn’t the only reason to have an understanding of a company’s value. A company is not unlike most other long-term assets, in that it’s useful to have a handle on how much it is worth. Being in an informed position at all times enables the company’s owners to understand what their options are, how to react in different business situations, and how their company’s valuation fits into the bigger picture.

The objectives for valuing a business can be divided into: internal motives, external motives, and mixed motives (being a combination of internal and external motives).

The Business Valuation Process

Every business valuation process differs based on which method you choose to evaluate.

Whatever method you use, the final aim is to find the company’s intrinsic value.

Depending on the company, whether private or public, entrepreneurs or individuals conducting the business valuation process, the method can differ. For example, should a company be measured based on its assets, its future free cash flows, recent transactions for comparable companies, or the sum of its real options? More often than not, valuation professionals seek to use a combination of these to arrive at an answer.

The valuation methods they use are summarized in the table below

More often than not, business valuation professionals use at least two methods when valuing companies, the most common being the DCF method and comparable transactions. These methods are popular because they’re widely understood, but also because the underlying numbers are easier to obtain. In the case of real options valuation, for example, the numbers which underpin the value of the business are far more difficult to objectively ascertain.

Business Valuation Methods

• Discounted Cash Flow Analysis
• Capitalization of Earnings Method
• EBITDA Multiple
• Revenue Multiple
• Precedent Transactions
• Liquidation Value / Book Value
• Real Option Analysis
• Enterprise Value
• Present Value of a Growing Perpetuity

1. Discounted Cash Flow Analysis

Discounted cash flow analysis uses the inflation-adjusted future cash flows to project a value for the business. The thinking behind DCF Analysis is that free cash flows are what endow shareholders with value and only that number that matters.

The problem then arises of how to accurately project discounted free cash flows (FCF), using a weighted average cost of capital (WACC) several years into the future. Even small differences in the metrics, growth rate, the perpetual growth rate and the cost of capital can lead to significant differences in valuation, fueling criticism of the method.

DCF = CF 1 / (1+r) 1 + CF 2 / (1+r) 2 + ....+ CF n / (1+r) n​

Where, CF 1 = The cash flow for year one, CF 2 = The cash flow for year two, n = Number of years, r = Discount rate

For example, let's consider a company with projected FCF of $1 million for the next 5 years. Assuming a discount rate of 10%, the company's future cash flows amount to approximately $3.79 million.

2. Capitalization of Earnings Method

The capitalization of earnings method is a neat, back-of-the-envelope method for calculating the value of a business, which in fact is used by DCF Analysis to calculate the perpetual earnings (i.e. all those earrings that occur after the terminal year of the DCF Analysis being performed).

Sometimes called the Gordon Growth Model, this method requires that the business have a steady level of growth and cost of capital.The numerator, usually the free cash flow, is then divided by the difference between the discount rate and the growth rate, expressed as fractions to arrive at an approximation of a valuation.

Market Capitalization = CF 1 / (r-g)

Where, CF 1 = Cash flow in the terminal year, r =  Discount rate , g = Growth rate

For example, consider a company with projected FCF of $1 million in the terminal year, a discount rate of 10%, and a growth rate of 5%. Using the capitalization of earnings method, the value of the company would be approximately $20 million.

3. EBITDA Multiple

The EBITDA multiplier is an excellent solution to the arbitrary nature of most valuation methods. Even Aswath Damodaran, the father of modern valuation, says that any valuation of a business should follow the law of parsimony: the most simple of two (or more) competing theories should hold sway in an argument.

On this basis, the EBITDA multiple - the multiplication of this year’s EBITDA figure by a multiplier agreeable to both the buyer and seller - is an elegant solution to the valuation dilemma.

Even those who consider this method too simplistic tend to use it as a guide for their valuations, underlining its strength.

4. Revenue Multiple

This method can be used in those circumstances where EBITDA is either negative or isn’t available for some reason (usually because sales figures are the only ones available when researching firms to acquire through online search).

Again, while you might say it’s just a benchmark - others would argue, with some justification, that the total sales of a business is the most important benchmark of all.

5. Precedent Transactions

This method may incorporate the EBITA and revenue multipliers or any other multiple that the practitioner wishes to use. As the title suggests, here the valuation is derived from comparable transactions in the industry.

So, for example, if widget makers have been trading at multiples of somewhere between 5 and 6 times EBITDA (or net income, or whatever indicator is chosen), Widget Co. would establish its value by performing the same iterative process.

The problem that then arises, is how similar are companies to others, even in their own industry?

Thus, for our money, this is more of a barometer of the market than a valuation method per se.

6. Book Value/Liquidation Value

The liquidation value is what Warren Buffett claims to have always looked at when seeing if businesses are overvalued on the stock market or not.This value is the net cash that a business would generate if all of its liabilities were paid off and its assets were liquidated today.

In a sense, calling this a valuation method for a business is a misnomer - this only gives you the value of part of the business.

But, to paraphrase Buffett, it allows you to see the ‘margin of error’ that you have with a valuation.

The logic goes that, even if everything goes wrong in management and the company’s sales fall dramatically after the acquisition, it can always fall back on the liquidation value.

7. Real Option Analysis

Proponents of real options analysis look at businesses as nothing more than a nexus of real options: the option to invest in opportunities, the option to utilize spare capacity, the option to hire more salespeople, etc.

Bringing together these options is the basis behind real options analysis for valuation.

This is most effective for firms with uncertain futures, usually those who aren’t yet cash generative: startups and mineral exploration firms, for example.

Of the valuation methods on this list, it’s by some distance the most complicated but its proponents include McKinsey and several of the world’s most prestigious business schools.

8. Enterprise Value

Enterprise Value (EV) is a method to measure the company’s total market value where we not only consider the company's equity but also its debt obligations and cash reserves.By including debt, we can provide a more accurate picture of a company’s value, especially in the context of mergers or acquisitions, as it represents the total cost to acquire the company’s operations.  

EV = Market Capitalization + Total Debt - Cash and Cash Equivalents 

For example, if a company has a market capitalization of $50 million, total debt of $20 million, and cash reserves of $5 million, its enterprise value would be $65 million ($50M + $20M - $5M).

9. Present Value of a Growing Perpetuity

The Present Value (PV) of a Growing Perpetuity is a valuation method which is used to estimate the total value of cash flows that continue indefinitely and grow at a constant rate. It's often applied in situations where cash flows are expected to continue indefinitely, such as in perpetuity. We can calculate the present value of a growing perpetuity with:

PV = C / (r-g)

Where, C = Cash flow at the end of the first period. r =  Discount rate, g = Growth rate

For example, if a company generates a cash flow of $1 million at the end of the first period, and the discount rate is 8%, with a growth rate of 3%. Then the present value of the growing perpetuity would be $20 million.

How to Pick the Right Valuation Method?

The previous section discussed how most business valuation professionals use at least two methods of valuation, and also that the valuation (the output) will ultimately only be as good as the numbers used to achieve it (the inputs).

After conducting a preliminary analysis of the company, whoever is conducting the valuation chooses the method, which is most suitable to the business and its industry.

There is no question that the biggest determinant of the valuation method used is available information. To take the example of comparable transactions, without any reasonably comparable transactions, there is no way that this valuation method can be conducted.

Here is an example of intangible assets valuation.

Even transactions in the same space from several years before cannot be considered accurate representations of a company’s value in the current environment.

In a similar vein, even the most commonly used valuation method, the DCF method, requires users to forecast free cash flows to a predetermined point in the future. Only in the most extreme cases - for example, a company with a remarkably small number of clients and pre-agreed contracts - is this feasible.

But information is just one of the factors which should determine which is the right valuation method to choose. The others are as follows:

Type of the company

If a company is asset-light, such as is the case with many service companies, it makes little sense to use the net-asset valuation method. Similarly, if most of a company’s value is in its branding or IP, it may make little sense to use the discounted cash flow method.

Size of the company

Larger companies tend to be applicable for a larger number of valuation methods. Small companies, with less information, are usually only subject to a handful of valuation methods. Bear in mind too that different valuation considerations are at play for each (e.g., higher valuation multiples for larger companies).

Economic environment

Regardless of which method is chosen, it’s never a bad idea to consider the economic environment that the company faces. But in more positive economic conditions, it’s important to be somewhat conservative when valuing in the understanding that all business cycles come to an end.

A further consideration for valuing a company is what the end user requires the valuation for. Some buyers will only look at the value of a company’s fixed asset value, be that technology, real estate, or even trucking. Others will only be interested in cash-flow generating potential (as is the case with most buyers of SAAS platforms).

How to carry out a successful valuation of a company

There are a few ways in which a valuation professional can ensure that, whatever the valuation method they choose, they’ll arrive at a number which approximates intrinsic value.

Successful valuation factors are:

A valuation which is heavily influenced by an opinion can be regarded as just that - an opinion.

The valuation should consider as much as possible; not just a company’s assets or its cash flows, but also its environment, and other internal and external factors.

Holistic does not mean detail for the sake of detail. Valuing Amazon doesn’t require making projections about the future prices of cardboard packaging.

Justifiable

Anyone reading the valuation should be able to arrive at the same conclusion as the individual conducting the valuation based on the information provided.

Business valuation providers

Business valuation is the bread and butter of investment banks and M&A intermediaries.

Even if a company has the wherewithal to conduct their own business valuation, it pays to hire a third party specialist for the expertise that they bring to the task. Even legal firms now typically have an in-house valuations expert.

Depending on the valuation method(s) used by the business valuation providers, the company can change the inputs over time to see how their valuation evolves.Accredited business valuation providers can also  ensure reliable and accurate valuations. These specialists adhere to industry standards and bring valuable insights to the table, enabling companies to make informed decisions regarding their valuation strategies.

Closing Remarks

The minute-by-minute fluctuation of the stock prices reflect the reality that there can never be a true consensus on a company’s valuation: everybody has their own.

Blue chip Investment banks, keen to let everybody know that they’re hiring the best quantitative analysts in the world, can also vary widely on price. The upcoming IPO of British chip manufacturer ARM is a case in point. The value of the IPO pitched by investment banks has ranged from $30 billion to $70 billion - a massive $40 billion difference. Most of these bankers will be wrong by billions of dollars, illustrating the difficulty of business valuations.

What links all of the methods mentioned here is that their users have, at one time or another, plugged numbers into a model which gave a number they thought was erroneous, only to replace the numbers moments later to arrive at a number they considered ‘more reasonable’. The best advice is to use as many measures as possible to arrive at a valuation. The more insights you can garner on its revenues, EBITDA, free cash flows, assets and real options, the better a perspective you gain of the company’s true value.

The DealRoom M&A Optimization Platform optimizes the M&A process to increase efficiency and accelerate synergy realization.Whether you need an advanced M&A pipeline tool to enable pipeline management or an end-to-end M&A platform to manage your complete lifecycle, DealRoom has the solution for you.

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Business Valuation

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on February 26, 2024

Are You Retirement Ready?

Table of contents, what is business valuation.

Business valuation is the process of estimating the economic value of a business or its ownership interest which involves taking into account its financial performance, assets, liabilities, and other relevant factors.

Business valuation is crucial for several reasons, including providing an accurate understanding of a company's value, facilitating informed decision-making, and ensuring transparency in financial transactions like mergers and acquisitions, sales, taxation, and legal disputes.

An accurate business valuation can help business owners and investors make strategic decisions about growth, financing, and exit strategies.

Additionally, business valuation is often required for legal purposes, such as taxation, estate planning, and dispute resolution. In these cases, a thorough and accurate valuation can help ensure compliance with legal requirements and protect the interests of all parties involved.

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Taylor Kovar, CFP®

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(936) 899 - 5629

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I'm Taylor Kovar, a Certified Financial Planner (CFP), specializing in helping business owners with strategic financial planning.

In my early consulting days, I encountered a family-run bakery facing a difficult decision regarding selling their business. Their uncertainty about the value of their business was compounded by emotional attachments. By conducting a thorough cash flow analysis, we were able to identify and highlight less obvious aspects of value, such as their unique recipes and loyal customer base. Adjusting their valuation to take these intangibles into account, they were able to secure a deal that surpassed their expectations.

Contact me at (936) 899 - 5629 or [email protected] to discuss how we can achieve your financial objectives.

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Methods of Business Valuation

Asset-based approach.

The asset-based approach to business valuation focuses on determining the value of a company based on the value of its tangible and intangible assets .

This approach involves identifying and valuing the company's assets , then deducting its liabilities to arrive at the net asset value . The asset-based approach is particularly useful for companies with significant assets, as well as for those in financial distress or facing liquidation.

However, this approach has its limitations, as it does not take into account the company's future earnings potential or the value of its intangible assets, which may be significant for some businesses.

Income-Based Approach

The income-based approach to business valuation focuses on estimating the company's value based on its ability to generate future cash flows or profits .

This approach involves projecting the company's future earnings, then discounting those earnings to their present value using a discount rate that reflects the risks associated with the company's operations.

The income-based approach is often used for valuing companies with strong growth prospects or those that derive a significant portion of their value from their ability to generate future cash flows.

However, this approach relies heavily on assumptions about future earnings and can be subject to significant uncertainty and subjectivity.

Market-Based Approach

The market-based approach to business valuation estimates the value of a company by comparing it to similar businesses in the market.

This approach involves analyzing comparable companies or transactions to determine valuation multiples, such as price-to-earnings or price-to-sales ratios , which are then applied to the company being valued.

The market-based approach is useful for valuing companies in well-established industries with a large number of comparable businesses or transactions. However, it may not be suitable for companies in niche markets or industries with limited comparables.

Factors Considered in Business Valuation

Revenue and profitability.

Revenue and profitability are critical factors in determining a company's value, as they reflect the company's ability to generate income and maintain sustainable growth.

A company with consistently strong revenue and profitability is likely to be valued more highly than a company with weaker financial performance.

In business valuation, analysts typically review historical financial statements to assess a company's revenue and profitability trends, as well as to identify any anomalies or patterns that may impact the company's value.

Assets and Liabilities

A company's assets and liabilities play a significant role in its valuation , as they represent the resources available to generate income and the obligations that must be met.

Assets, both tangible and intangible, can contribute to a company's overall value, while liabilities can reduce it.

In the valuation process, analysts review a company's balance sheet to identify and value its assets and liabilities, taking into account factors such as depreciation , market conditions, and potential future growth or decline in asset values.

Cash flow is a critical factor in business valuation, as it represents the company's ability to generate cash from its operations, which can be used to fund growth, pay dividends , or meet debt obligations.

A company with strong, consistent cash flows is generally considered more valuable than a company with volatile or weak cash flows.

Analysts typically examine a company's cash flow statement to assess its cash generation and use patterns, as well as to identify any potential issues or opportunities that may impact its value.

Industry and Market Conditions

Industry and market conditions can have a significant impact on a company's value, as they influence factors such as demand for products or services, competitive dynamics, and regulatory environment.

A company operating in a growing industry with strong market demand may be valued more highly than a company in a stagnant or declining industry.

During the valuation process, analysts consider the company's industry and market conditions, as well as any trends or external factors that may influence its future performance and value.

Management and Employee Quality

The quality of a company's management and employees can also impact its value, as it influences the company's ability to execute its strategies, adapt to changes, and maintain a competitive edge.

Companies with strong, experienced management teams and skilled employees are often valued more highly than those with weaker leadership or workforce capabilities.

In business valuation, analysts may assess the company's management and employee quality through factors such as executive and employee backgrounds, turnover rates, and organizational structure .

Intellectual Property and Patents

Intellectual property (IP) and patents can significantly contribute to a company's value, particularly in industries such as technology, pharmaceuticals, or creative sectors, where innovation and unique assets are critical.

Companies with strong IP portfolios or valuable patents are often valued more highly than those with limited or less valuable IP assets.

During the valuation process, analysts may assess the value of a company's IP and patents by considering factors such as the potential future cash flows generated from those assets, the competitive advantages provided, and the remaining life of the patents.

Types of Business Valuation

Fair market value.

Fair market value is a type of business valuation that estimates the price at which a company would change hands between a willing buyer and a willing seller, with both parties having reasonable knowledge of the relevant facts and neither being under any compulsion to buy or sell.

This is often used in legal contexts, such as taxation and estate planning, as well as for setting transaction prices in business sales or acquisitions .

Investment Value

Investment value is a type of business valuation that estimates the value of a company to a specific investor, taking into account the investor's unique circumstances, objectives, and risk tolerance .

This type of valuation may differ from the fair market value, as it reflects the individual investor's perspective rather than the broader market.

Investment value is often used by investors when evaluating potential investments or determining the value of their existing holdings in a company.

Liquidation Value

Liquidation value is a type of business valuation that estimates the net amount a company would realize if it were to sell its assets and settle its liabilities immediately.

Liquidation value is typically lower than other types of valuation, as it assumes a rapid sale of assets, often at a discount to their fair market value.

This is often used in situations where a company is facing financial distress or bankruptcy and needs to quickly monetize its assets to satisfy its obligations.

Uses of Business Valuation

Sale of business.

Business valuation is essential in the sale of a business, as it provides an objective estimate of the company's worth, which can be used as a basis for negotiating the transaction price.

A thorough and accurate valuation can help business owners ensure they receive a fair price for their company and enable potential buyers to make informed decisions about the investment.

Mergers and Acquisitions

In mergers and acquisitions , business valuation plays a crucial role in determining the value of the target company and assessing the potential benefits and risks of the transaction.

A comprehensive valuation can help acquirers identify synergies, assess the target company's financial health, and determine a fair offer price.

Likewise, for the target company, a thorough valuation can help its owners understand their company's worth and negotiate favorable terms in the transaction.

Taxation and Estate Planning

Business valuation is often required for taxation and estate planning purposes, such as determining the value of a company for tax reporting, gift tax , or inheritance tax purposes.

An accurate valuation ensures compliance with tax regulations and helps business owners and their heirs plan for future tax obligations.

In estate planning , business valuation can also assist business owners in developing succession plans and strategies to preserve and transfer their company's value to future generations.

Litigation and Dispute Resolution

In litigation and dispute resolution, business valuation is often necessary to determine damages, quantify losses, or assess the value of a company in the context of legal disputes, such as shareholder disputes, divorce proceedings, or contractual disputes.

A thorough and accurate business valuation can help parties in a dispute reach a fair resolution and support their legal claims or defenses.

Business Valuation Process

Preparing for valuation.

Before beginning the business valuation process, it is essential to gather all necessary information about the company, including its financial statements , business plan, and other relevant documents.

This information will be used to analyze the company's financial performance , assets, and liabilities, as well as to assess its growth prospects and industry position.

It is also crucial to engage the services of a qualified business valuation professional or firm, who can provide an objective, expert assessment of the company's worth.

Selecting a Valuation Method

Once the necessary information has been gathered, the next step is to select the appropriate valuation method based on the company's characteristics and the purpose of the valuation.

The choice of method will depend on factors such as the company's industry, size, growth prospects, and the availability of comparable transactions or companies.

The selected valuation method should be appropriate for the company's unique circumstances and provide an accurate, objective estimate of its worth.

Collecting and Analyzing Data

After selecting a valuation method, the next step is to collect and analyze the relevant data, such as financial statements, industry reports, and market data.

This analysis will inform the valuation process by providing insights into the company's financial performance, market position, and growth prospects. The data analysis should be thorough and accurate to ensure a reliable valuation.

Applying Discounts and Premiums

In some cases, it may be necessary to apply discounts or premiums to the company's valuation to account for factors such as liquidity , marketability, or control. Discounts and premiums should be applied judiciously, based on objective criteria and supported by empirical evidence.

Finalizing Valuation Report

Once the valuation process is complete, the valuation professional or firm will prepare a comprehensive valuation report that outlines the methodology, data, and assumptions used in the valuation, as well as the final valuation result.

This report should be clear, well-organized, and supported by relevant data and analysis.

The Bottom Line

Business valuation is the process of estimating a company's worth by analyzing its financial performance, assets, liabilities, and other relevant factors. It is essential for various purposes, including sales, mergers and acquisitions, taxation, and legal disputes.

There are several methods of business valuation, including asset-based, income-based, and market-based approaches. Each method has its unique characteristics and is suitable for different situations and types of businesses.

The choice of the valuation method depends on factors such as the company's industry, size, growth prospects, and the availability of comparable transactions or companies.

Various factors are considered in business valuation, including revenue and profitability, assets and liabilities, cash flow, industry and market conditions, management and employee quality, and intellectual property and patents.

Understanding the different valuation methods, factors, and types of valuation can help business owners, investors, and other stakeholders navigate the complex world of business valuation and ensure that they have an accurate, objective assessment of a company's value.

Business Valuation FAQs

What is business valuation.

Business valuation is the process of determining the economic value of a business or company.

What are the methods used in business valuation?

There are three methods used in business valuation: asset-based approach, income-based approach, and market-based approach.

What factors are considered in business valuation?

The financial factors considered in business valuation include revenue and profitability, assets and liabilities, and cash flow. Non-financial factors include industry and market conditions, management and employee quality, and intellectual property.

What are the types of business valuation?

The three types of business valuation are fair market value, investment value, and liquidation value.

What are the uses of business valuation?

Business valuation is used for a variety of purposes, including the sale of a business, merger and acquisition, taxation and estate planning, and litigation and dispute resolution.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

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Run » finance, what is a business valuation and how do you calculate it.

There are multiple ways to find the economic value of your business, with different calculations that can be used for different purposes.

How do you put a price on the time, effort and passion you’ve put into building a successful small business? It can be hard to objectively assess how much your venture is worth after putting so much work in over the years. This is where business valuation calculations, ideally handled by a third-party expert, can play a role. Business valuations are used for mergers, acquisitions, tax purposes and more. Here’s how business valuations work and how to calculate the economic value of your company.

[Read more: 3 Things to Consider When Selling a Business During a Pandemic ]

What is a business valuation?

A business valuation assesses the economic value of part or all of a business. Business valuations are used in a number of circumstances, including to determine the sale value of a business, to establish partner ownership, for tax purposes or even in divorce proceedings.

Generally, the valuation process analyzes all aspects of the business, including the company’s management, capital structure, future earnings and the market value of its assets. In the United States, business valuations are usually carried out by a professional who is Accredited in Business Valuation (ABV). This certification, awarded by the American Institute of Certified Public Accountants, is given to CPAs who pass an exam and meet minimum standards set by the AICPA.

If you’re seeking financing from lenders, investment bankers or venture capitalists, you may need an ABV-certified professional to help carry out your business valuation. If you’re simply looking to understand how much your venture is worth, you can carry out your own analysis using one of the business valuation methods listed below.

[Read more: How to Calculate a Business Valuation ]

Business valuation methods

There are three common methods to evaluating the economic worth of a business. These categories are:

• Asset-based methods : Sum up all of the investments in the company to determine the value of the business.
• Earning value methods : Evaluate the company based on its ability to produce wealth in the future.
• Market value methods : Estimate what the company is worth based on similar businesses that have recently been sold.

In general, try to use more than one method to get the most accurate depiction of your business value.

There are pros and cons to each of these approaches to valuation. An asset-based approach, for instance, works well for corporations in which all assets are owned by the company and will be included in the sale. But, for a sole proprietor, this approach can be more difficult; which assets should be considered personal, versus business-related?

Generally, the two main earning value methods — capitalizing past earnings and discounted future earnings — are used when a company is seeking to buy or merge with another company. Market-value approaches are the least accurate and can lead to a business being under- or overvalued.

How to calculate a business’s value

Often, business valuations are performed by a licensed professional. To find an ABV who can help, look for someone registered with the American Society of Appraisers (ASA).

If you’re simply looking to get a basic idea of what your business is worth, there are a few steps you can take to get a rough estimate. Start by calculating your seller’s discretionary earnings (SDE) . SDE is like EBITDA, with owner’s salary and owner’s benefits added back in. “Start with your pretax, pre-interest earnings. Then, you’ll add back in any purchases that aren’t essential to operations, like vehicles or travel, that you report as business expenses. Employee outings, charitable donations, one-time purchases and your own salary can all be included in your SDE,” wrote NerdWallet .

Once you have your SDE, take stock of your assets, do a little market research to see similar businesses have sold for, and pay attention to industry trends to see if you can ask for a higher valuation.

In general, try to use more than one method to get the most accurate depiction of your business value. “A general rule of thumb in business valuation is that you will want to use multiple methods. Using three to four methods will allow you to estimate fair value with more accuracy,” wrote the experts at The Balance .

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Small Business Valuation Methods: How to Value a Small Business

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Knowing how much your business is worth is not only for massive corporations — small business owners can benefit from this knowledge too. Your business’s valuation can help you to create more accurate and effective goals and is essential if you’re looking to sell your business. 

In this article, learn how to value a business, when you should find out your business’s value, and how to improve your valuation.

How to Value a Small Business

While you may be pleased by the results, your business’s value isn’t a vanity metric. A proper small business valuation can be important if you’re planning on selling your business, merging, buying out other owners, applying for a business loan , offering employees equity, or going through a major life event. 

However, there are different ways to value a small business, and the appropriate method can depend on the size of the business and purpose of the valuation. Understanding the common methods and why the outcomes will differ can be important for small business owners or corporate executives alike.  

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There are several methods for valuing a small business based on its balance sheet, earnings, projections about the future, and recent sales of similar businesses. Each method has its pros and cons, and can be used in different circumstances. Here’s a quick look at five popular valuation methods:

Adjusted net asset method

An asset-based valuation can be fairly straightforward if your balance sheet is in order, as it largely mirrors what the balance sheet shows. First, add up the value of the business assets and subtract its liabilities to get the starting value. 

Then, to get a more realistic valuation, you may want to put more thought into the numbers. The adjusted net asset method requires you to use your knowledge of the business and current markets to adjust the value of the assets and liabilities.

For example, you may have accounts receivable that are assets on your books but you know you won’t likely collect the full amount. You should adjust your assets down to reflect real-world values.

The adjusted net asset method can be useful if you’re valuing a company that doesn’t have a lot of earnings or is losing money. It’s also a common valuation method for holding companies that own parts of other companies or real estate investments. If you’re considering selling your business, you may also want to perform this valuation to set a floor price. 

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Capitalization of cash flow method.

The capitalization of cash flow (CCF) method is the simpler of the two main income-based methods that you may want to consider when valuing companies that generate income.  

To calculate the business’s value using the CCF method, you’ll divide the cash flow from a specific period by a capitalization rate. You’ll want to use one period’s worth of sustainable and recurring cash flow from the business, and may need to make adjustments if there were recent one-time expenses or income events that you don’t want to include in the results. 

The capitalization rate (cap rate) is the business’s expected rate of return. This is the rate of return a buyer could expect to earn (not included their salary) if they purchase the business. It’s often around 20% to 25% for small businesses.

The simplicity of the CCF method can also impact its predictiveness. However, the CCF method can be a worthwhile valuation method if you’re looking at a mature and stable company that’s unlikely to see big swings in its cash flow. 

Discounted cash flow method

The discounted cash flow (DCF) method is another income-based method. It uses the business’s projected future cash flow and the time value of money to determine the current value. While the CCF is best used with companies that have steady cash flows, the DCF is best for companies that are expected to significantly grow or shrink in the coming years. 

The time value of money is the idea that money is worth more today than it is in the future. For example, if you have a thousand dollars today, you can invest the money, earn interest, and have more than a thousand dollars in five years. A discounted cash flow model takes this into account, which is why it can be also helpful if you’re trying to compare different investment opportunities. 

While the calculations can be a little complex, you can find an online business valuation calculator  that can help. But you’ll still need to figure out which numbers to plug into the calculator.

The business’s cash flow statement is a good place to start, and projected cash flows if they’ve already been created. Additionally, you’ll need to know the discount rate, or weighted average cost of capital (WACC), which can require more complicated calculations. Think of the WACC as the rate the business needs to pay to finance its working capital and long-term debts. 

You’ll also need to decide how many years’ worth of cash flows you want to include. You could base your answer on how confident you are about the future cash flow projections, and use the same number of years if you’re trying to compare DCFs for multiple investments. 

Market- based valuation method

A market-based valuation depends less on the specific business than the current market conditions. With the market-based valuation method, the business’s current market value is determined by comparing the recent sale prices of similar companies.

Finding relevant comps can be difficult if you have a small business, but you may still want to look for at least a few comps if you’re planning on buying or selling a business. If you’re hiring an appraiser, they may also have access to databases with relevant findings. 

Even if the comps aren’t physically located nearby, an appraiser may find similar sized businesses in the same industry and can then make adjustments based on the area. You can also use the results in combination with the other valuation methods to determine a business’s value. 

Seller’s discretionary earnings method

The previous four valuation methods can be used for small businesses and large, publicly traded companies alike. However, the seller’s discretionary earnings (SDE) method is solely used for small business valuation. 

If you’re planning on selling or buying a small business, the SDE method might be best because it can help the buyer understand how much income they can expect to earn each year from the business. To calculate the SDE, you’ll need to determine how much cash it takes to run the business. 

You can start with the business’s earnings before interest and taxes (EBIT), or for a more thorough view, the business’s earnings before interest, taxes, depreciation, and amortization (EBITDA), which you can determine from the financial statements. Then, add back the owner’s compensation (because the new owner can choose a different salary) and benefits, such as health insurance. Also, add back in non-essential, non-recurring, and non-related business expenses. These could include travel, one-time consulting fees, and business use of a personal vehicle. 

Because the SDE is often used when a small business is sold, it’s not uncommon for there to be debates about some of the numbers. These can especially arise around the expenses that get added back to determine the value.

As an example, the seller might want to call a search engine optimization project a one-time expense and add that portion back into the earnings to increase the valuation. However, the buyer might consider this to be an ongoing project that needs to be revisited and paid for each year. They’ll need to come to an agreement before a sale can move forward. 

Reasons to Value Your Business

• You want to sell your business 
• You’re trying to attract investors
• You’re buying out the other owners 
• You’re offering employees equity
• You’re applying for a loan or line of credit
• You want to better understand your business’s growth
• You need values for tax-planning purposes

The list can go on as small business owners’ personal and professional lives revolve around their business and its potential. While many of the reasons above involve changes in the business or its ownership, a personal event (such as a marriage or divorce) may also spur the valuation. 

How to Prepare for a Business Valuation 

If you’re conducting a business valuation for informal purposes, you may want to do it on your own. However, hiring a professional appraiser (you can find one that’s part of the American Society of Appraisers ) or business valuation expert (banks, lenders, and accountants may offer the service) could be a good idea if you need the analysis for more serious matters. The business valuation process can be complex for official purposes, and it’s good to have a professional guide you.

In either case, there are a few steps you can take to prepare for the valuation: 

1. Get your financial documents in order

Every valuation is going to be based, at least in part, on your business’s finances. Even the market-based valuation method requires your business’s financial information to find suitable comps. 

At a minimum, you’ll want the previous three to five years’ worth of your business tax returns and financial statements , including the balance sheet, income statement, and cash flow statement. Comb over these statements to make sure everything is accurate and up to date. 

Other finance-related documents, such as sales reports and industry forecasts can also be important, particularly for DCF and market-based valuations. 

2. Organize other essential documents

Depending on your reason for the business evaluation, you may also want to have copies of your business licenses, permits, deeds, and certifications available, along with any ongoing contracts with insurers, creditors, vendors, and clients. 

If you’re planning on selling the business or looking for business loans for your small business, you’ll likely need to share these along with your financials. You can also pull up your business credit reports and get your business credit scores from Nav to share with creditors and potential buyers. 

3. List additional intangible assets

Your business’s tangible assets (such as cash, property, and equipment) should be listed on your balance sheet. Some intangible assets may be listed there as well, such as copyrights or patents. But think about other intangible assets that may be providing value. 

An extensive email list , loyalty club, good rankings in search engine results, engaged social media profiles, and positive online reviews can all help you attract and retain customers. These types of assets could help improve your business’s valuation even if they don’t have a value on its balance sheet. 

Improving Your Small Business Valuation

Your business’s valuation is going to depend on how much money it makes and increasing revenue and cutting costs are the core essentials to improving your valuation. However, you’ll need to decide where you want to focus your energy.

Hiring a professional appraiser or evaluator might actually be a good first step, as they can give you the current valuation and help you identify your business’s strengths and weaknesses. They may even be able to offer suggestions for improvement based on what they’ve seen work for other businesses. 

There are also ways to demonstrate the business’s value to potential buyers that don’t rely on the numbers. For example, if you can show how processes and systems are in place that will keep the business running smoothly after you leave, buyers may be more willing to agree to a higher valuation. 

Or, perhaps you can highlight how your employees are happy and take ownership of their work. Low turnover can save the business money, and responsible employees can make the transition to new management easier. 

Make a Practice of Regularly Valuing Your Small Business

Learning how to estimate the value of a company can be important for small business owners for many reasons. Even if you’re not planning on selling your business or applying for financing, regularly performing a quick-and-dirty business valuation can help you track your progress over time. Taking a deeper dive into the valuation may help you uncover opportunities for growth.

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How do you calculate the value of a small business?

In order to calculate the value of your business, you can start with a simple formula: Business value = assets – liabilities Your business assets are anything your business owns, including real estate, equipment, and inventory, as well as intangible assets like patents, intellectual property, or any incoming royalties. Liabilities are anything you owe, such as accounts payable, business loans, and even payroll.

What is the rule of thumb for valuing a business?

Ultimately, supply and demand will determine the value of a business. But rules of thumb can help provide a good idea of how much a business is worth. While this will change from business to business, you can use a percentage of your last year of sales as a multiplier to determine the value of your business. 

How many times profit is a small business worth?

Determining how much your small business is worth based on profit isn’t as straightforward as it sounds. There’s not a single formula, as things like your industry, past performance, and relative risk can all play a role in determining your business’s worth. If you use EBIT or EBITDA, the multipliers to determine a business’s value, your numbers can range from 80% of future maintainable earnings (FME) to over 500%.  In general, however, most companies that make less than $5 million a year sell for less than three times EBIT, and companies that make more than $5 million a year are likely to sell for more than three times EBIT. Meanwhile, small businesses that make less than $1 million tend to sell for less than twice their EBIT. 

How much is a business worth with $1 million in sales?

There’s no single calculation that can determine what a business is worth without comparing it to other businesses in the same industry. You also need to take other factors about the business into account, such as how long you’ve been in business.  Here’s an example., If your company is making $1 million per year with a profit of $200,000 EBITDA, you would say your business is making 20% profit. In this case, your company would be worth between $600,000 and $1 million. However, many would simply say that your business’s fair market value is one times your total revenue. In this case, your company would be worth $1 million.  It’s a good idea to get a professional evaluator to help you determine the value of your company, sort through the complexities of business valuation, and make sure you have a non-biased view of your company’s worth.

How do you value a private small business?

Most small businesses are privately owned, rather than publicly owned (in other words, selling shares on the marketplace). Thus, you would follow the standard formula of assets minus liabilities to find the value of your private small business.

How much is a small business usually worth?

A small business is typically worth two to three times its annual revenue. So if your business makes $150,000 per year, its worth would likely be $300,000 to $450,000.

How much is a small business worth when it is sold?

A small business usually sells for what it is valued at, which is most often two to three times its annual sales. If a business makes $50,000 per year, it would likely sell for between $100,000 and $150,000 per year.

What would be the value of a small business that has $500,000 in assets?

You can’t use one calculation to figure out how much a business is worth without doing a comparison with other companies in the same industry. Other factors like time in business matter as well. In this example, you know you have $500,000 in assets. You would then subtract your liabilities to get your starting value, and let’s say you have $100,000 in liabilities. So your starting value is $400,000. You would then need to adjust this value based on the current markets.  Consider getting a professional to help you find your business’s value and ensure you have an objective view of your company’s value.

How do you value a company with no profits?

There are many companies that are pre-revenue, meaning they have yet to bring in a profit. It’s still possible for investors to evaluate what the company is worth, though. Investors look at factors such as the experience and skills of the management team, the market size, how much competition there is, and partnerships and engagement levels.

How do you value a small business with no assets?

The most common way to value a business that doesn’t have assets is the market-based business valuation model. This finds the business’s current market value by comparing it to other similar companies that have sold recently.

What is the formula for small business valuation?

Many small businesses ask, “What is the valuation formula?” when they’re trying to find out how much their business is worth. There are five most commonly used formulas to find a business’s valuation: adjusted net asset method, capitalization of cash flow method, discounted cash flow method, market-based valuation method, and the seller’s discretionary earnings method. Each has pros and cons, as well as different instances that it works best in.

What ratios do you use when valuing a company?

There are several financial ratios that can help you understand the worth of a public company, which is a company traded on the stock market. These include the price-to-earnings ratio, the price-to-book value ratio, the price-to-sales ratio, the price-to-cash flow ratio, and the price or earnings-to-growth ratio. Each of these ratios can be useful tools for small business owners.

How do you value a self-employed business?

If you’re running a self-employed business, this means you work for yourself and are not an employee of another business. Small business owners are considered self-employed. You’ll follow the standard calculation of assets minus liabilities to find your simple value.

What are the advantages of a valuation for a small business?

Finding the valuation of your small business can help you see how it’s performing and create more realistic and effective goals. You’ll better understand your sale value when compared to your competition. You’ll also need to complete a valuation if you plan to sell your business.

This article was originally written on January 31, 2020 and updated on January 17, 2024.

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Tiffany Verbeck

Tiffany Verbeck is a Digital Marketing Copywriter for Nav. She uses the skills she learned from her master’s degree in writing to provide guidance to small businesses trying to navigate the ins-and-outs of financing. Previously, she ran a writing business for three years, and her work has appeared on sites like Business Insider, VaroWorth, and Mission Lane.

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How to Value a Business?

Table of content, price is not equal to value, common valuation scenarios, discounted cash flow (dcf) valuation method, economic value added (eva) method, stock market valuation multiples, recent transaction method, replacement cost analysis, net asset value method, conclusion on how to value a business – use triangulation.

When you are asked to perform a business valuation, you might wonder how to do this?  Simply putting a price tag on a product is not the same thing as valuing a business. Valuing a business can either be simple or complex but in any case, you will need to understand which business valuation methods to use.

In this article, we want to outline and review the pros and cons of common business valuation methods used by professionals in Investment Banking, Mergers and Acquisitions (M&A), Private Equity, Corporate Development, Equity Research, Controlling, and Finance functions . The goal of this article is to provide a better understanding of each valuation method , how to use them, their pros and cons in order to obtain a deeper understanding of how to value a business.

Business Valuation – The Top 4 Reasons

A business valuation normally is needed whenever a change in the ownership or financing structure of a company is intended. Here are the four most common reasons when a business valuation will be needed:

• Business Sell/Purchase requires a clear understanding of the intrinsic value of a business. In any Mergers & Acquisitions (M&A) transaction , the business valuation is used as the basis for price negotiations during the sale and purchase process. Such business transactions normally may include entire or partial acquisitions or divestitures of businesses.
• Mergers are a special form of an M&A transaction, as shareholders of two different companies enter into an agreement to exchange their shares in order to merge the two companies. Shareholders will end up with owning shares of the combined company. In this case, a business valuation will have to value each company separately on a standalone basis to determine the exchange ratio for the shares based on the relative equity valuations.
• Fundraising exercises, especially for startup companies, require an agreement on how much equity stake new investors will receive. The equity stake together with the amount of money raised determine the implied pre- and post-money valuation of the business . In order to check if this valuation makes economic sense, investors such as business angels, private investors, Venture Capitalists or Private Equity will normally want to obtain clarity of such business valuation can be justified.
• Change in Equity Ownership in order to issue, transfer or buy-back shares of shareholders or employees, a business valuation will be needed. This can either be performed on request or a business valuation can also use a pre-agreed formula to value a business.

There are many more reasons why a business valuation might be needed. However, for our purposes, the point is that we need to be aware of the objective of our valuation exercise and therefore include this when choosing the appropriate valuation method to use when deciding how to value a business.

What is Value?

According to Merriam Webster , value is defined as the monetary worth of something. It is also defined as a fair return or equivalent in goods, services, or money for something exchanged. Essentially, value is something which is regarded as having significance, benefit, worth, lasting usefulness or utility.

Value, as an economic concept, is best explained by the father of modern economics, Adam Smith, in his diamond-water paradox . The paradox is, Water is very valuable because it is needed for human survival, yet it has a much lower price compared to a diamond. On the opposite, a diamond is mainly used as an ornament and not vital for human survival yet is priced very high. Value varies from user to user or customer to customer and value is, therefore, a subjective concept . Value largely depends on qualitative factors such as preferences, utility, expectations, and levels of satisfaction. 

Most valuation methods normally result in an estimation where the value lies as Valuation methods base on certain assumptions which by itself depending on the appraiser’s point of view. Therefore, if you ask two or three different business appraisers what the value of a business is, you might easily get two and three different answers. In order to understand the difference between these valuations, you will have to look at their assumptions and which valuations methods they are using.

As we deal with valuation estimates, it can be more meaningful to talk about valuation ranges where a reasonable valuation of business most likely should lie within rather than a single point result. Communicating a valuation range allows us to admit the inherent inaccuracy of each valuation method and to be transparent about it.

Opposite to value, price, on the other hand, depends on varying factors such as demand and supply of the good or service, how much was spent on buying the materials needed to make the product, how much was spent on labor, how many other companies are making the same product and how much they sell it for, among other factors.

Warren Buffet, Chairman and CEO of Berkshire Hathaway, is one of the most famous and successful value investors in history. In a CNBC interview in 2017 , he revealed Benjamin “Ben” Graham is one of three (first his father, Howard Buffet, and second his wife, Susan Buffet) people he credited for his success. In a 2008 letter to Berkshire Hathaway’s stakeholders he wrote: “Long ago, Ben Graham taught me that “Price is what you pay; value is what you get” (Source: Warren Buffett).

In business, the value of a company depends on the underlying valuation scenario , as the following valuation concept demonstrates:

• Book Value: The book value of a company is the total value of the company’s assets minus outstanding liabilities reflected in its balance sheet. The Book value normally represents the value of the purchased assets at a cost but normally excludes future benefits as the value is based on accounting figures and not economic valuations (with some exceptions depending on accounting standards used).
• Liquidation Value: This represents the remaining worth of a company’s assets when the company is going out of business after all the assets are sold and all liabilities are paid off. Intangible assets such as goodwill, intellectual property and trademarks will only have value if they can be sold in liquidation scenarios, otherwise, they will end up worthless if they don’t find a buyer. Calculating the liquidation value becomes relevant in insolvency scenarios.
• Going Concern Value: The term “going concern” is a fundamental concept in accounting as here we assume that a business will keep operating for the foreseeable future. This avoids having to value the assets at their liquidation values and allows to attribute more value to each asset as they can be put to work in the future. In simple terms, the company can keep using the assets to generate future income. Going Concern Value is the opposite of Liquidation Value and normally leads to higher valuations.
• Intrinsic Value: This represents the actual value of the company including intangible assets such as goodwill, intellectual property, patents, brand trademarks. The intrinsic value normally is determined through income-based valuation methods as fundamental analysis and argumentation are required to understand their valuations.
• Fair Value: Oftentimes, this is interchanged with market value but the two are not the same. Fair value represents the estimated worth of an asset and liability and is derived fundamentally (does not fluctuate and not influenced by market forces).
• Market Value: This refers to the current or recently-quoted price of an asset that is traded in an open market place such as a stock exchange. This commonly refers to publicly listed companies and generally represents the sentiment of the market and not entirely the present and the actual state of a company. For property valuations , also well-functioning property markets can be considered to lead to market values.

Business valuation is a process used to determine the intrinsic value, fair value or market value of a business (enterprise value). By subtracting net financial debt from the enterprise value , we arrive at the equity value. The art of valuation now is to select the appropriate valuation methods in light of the circumstances and data availability. Once the valuation results are available, their data points can be used to triangulate where a reasonable valuation of a business should lie within. As any valuation is a subjective estimate, it is therefore imperative that before conducting such valuation, you must know the purpose of the valuation exercise. More often than not, the purpose will greatly influence the standard of value, the methods used, the level of research performed, and possibly the date of the valuation.

The 3 Main Valuation Approaches

Each valuation method can be attributed to one of the three main valuation approaches which allow to better understand the conclusions which can be drawn of the corresponding business valuation methods.

• Income Approach – determines the value by estimating the business’ value based on the expected income or cash flows which can be generated from a business. It’s normally based on fundamental analysis.
• Market Approach – determines the value based on observable multiples of similar companies or transactions.
• Cost Approach – determines a company’s value by calculating the costs it takes to build a similar business or asset or looks at a company’s asset value .

In the above chart, we also include Economic Value Add (EVA) analysis and Leveraged Buyout (LBO) Analysis as part of the income approach. Each of the valuation methods of the income approach is using a different definition of the underlying income or cash flow streams, therefore looking at a valuation case from a different angle. Valuation methods based on the income approach normally use fundamental analysis to build up their case and lead to a more detailed understanding of how a company can create value than when using market or cost-based valuation approaches.

The market approach mainly bases on observable market multiples from either the stock market or private transaction data and reflects market conditions. However, market prices paid might be distorted by the current market conditions. Therefore, for any solid business valuation , these methods normally only serve as a complement to fundamental analysis.

Where it is not possible to estimate the income (or revenues) or where estimates lie too far apart, one needs to switch to a cost-based valuation approach. Costs estimates are easier to obtain, however, as they do not include any form of revenue, their explanatory power lies significantly lower than income-based valuation approaches. Therefore, an income-based valuation approach in most cases appears superior to a cost base valuation approach.

Now that we understand a bit more to which approach each valuation method belongs, let us review the available methods to choose when having to decide how to value a business.

Valuation Methods of the Income Approach

The income approach relies upon the main assumption that the value of a business should be equal to value one can reasonably expect to derive from the business in the future in the form of income or cash flows. As the income or cash flow streams lie in the future, income-based valuation methods take into account the risk via the discount rate (or capitalization rate) which is used to convert future cash flows into their present values.

The two most frequently used valuation methods under this approach are the Discounted Cash Flow (DCF) valuation method and the Capitalized Earnings valuation. Both methods are very common for business valuations but also for property valuations. Let’s discuss each method in the following:

The DCF valuation method forecasts a company future Free Cash Flows to Firm (FCFF) and uses the discount rate to calculate the net present value of those. DCF valuation is one of the most widely used valuation methods and today is not only used for business but also for property valuations .

To conduct a DCF valuation analysis you will need three main things:

• 5 Year financial plan of a business
• Discount Rate
• Terminal value assumptions

The forecast horizon should be a minimum of 5 years, so that means the company will need to develop a business and financial plan for this period. The financial plan should go beyond a pure profit and loss forecast as the DCF methods require to determine the Free Cash Flows to firm. This can easily lead that the analysis becomes a bit more complex as a forecast of the Balance Sheet and Cash Flow Statement will be needed.

The discount rate often is estimated by the company’s Weighted Average Cost of Capital (WACC), the average costs of the financing sources of the business. One advantage of the WACC concept is that the WACC can easily be compared to the Internal Rate of Return (IRR) of an investment project. Where the IRR is higher than the WACC, such investment will generate positive net present value and therefore will enhance the company’s DCF value.

You will also need a framework to estimate the company’s terminal value to account and credit value for the period beyond the 5-year forecast. Simple ways to estimate a terminal value are by using the Gordon growth model with the formula FCFF(WACC-g) or simply by using an exit EV/EBITDA multiple.

Below example shows a simple DCF valuation:

Pros/Cons of the DCF valuation method:

Capitalized Earnings Method

The capitalized earnings method values a business by simply capitalizing the company’s income or cash flows. Capitalized Earnings valuations are normally based on historic financials as there is no financial plan available (if there would be a financial plan available one would use the DCF method). Also, as income for businesses fluctuates over the years, many valuation experts use a normalized figure of income as they are afraid of relying on a single year in order to avoid that the valuation becomes biased to an outlier. Below example shows a capitalized earnings valuation for a business based on a three-year average of the NOPAT (Net Operating Income adjusted for taxes):

As you can see the valuation result lies lower than the DCF valuation as this valuation bases on historic financials which in this case does not include the upside visible in the company’s financial plan.

This valuation method is also commonly used for property valuation purposes in real estate as rental income in most cases provides a very stable income stream and income does not fluctuate very much (for businesses cash flows and profits normally fluctuate more over the years). For property valuation purposes, the capitalized earnings valuation can either be applied on income (Gross Cap Rate) or on Net Operating Income (Net Cap Rate).

Pros/Cons of the Capitalized Earnings valuation method:

The EVA valuation method seeks to value a company be focusing on the economic value add created by the company compared to its cost of capital.  Initially, this method was designed to help with performance measurement and developed by Stern Value Management. The method is useful to analyze historic results as below simplified example shows.

In practice, the method is difficult to use as there are many adjustments required to account for all the effects NOPAT. The main question that this method answer is if the company has created more value than it has to generate to service its cost of capital.

Now the EVA method can also be applied to forward-looking results and in this way be used to value a company. The starting point of any EVA valuation is the Invested Capital today to which the present values of all future Economic Value Adds are added. Future Economic Value Adds can be forecasted for a couple of years but will have to be capitalized at some point to account for the time beyond the initial forecast period.

The EVA method sometimes is also used as an alternative and more precise way to the terminal value as part of a DCF Valuation (ROIC value driver formula).

Pros/Cons of the EVA valuation method:

Leveraged Buyout (LBO) Analysis

LBO analysis determines a business value from an investor’s point of view, normally based on a holding period scenario of 5 years and the required hurdle rate LBO analysis is widely used by Private Equity funds who need to achieve a certain return for their investors.

The underlying rationale is that an investor would be willing to pay a purchase price only up to a certain amount which just allows him to achieve his minimum hurdle rate on his investment during a certain time period. This approach offers a special way of how to value a business. The focus of the analysis lies in the Internal Rate of Return (IRR) and assumes an entry and exit scenario.

See below-simplified example. In this case, the calculated IRR is 25%. If the Hurdle rate is 25%, it means the investor can afford to pay a purchase price of up to $220,000 while obtaining $50,000 debt financing. For him, it would only be possible to pay a higher price (and value the business higher) if he lowers his hurdle rate.

Pros/Cons of the LBO Analysis

Market-Based Business Valuation Methods

Market-based valuation methods focus on observable market multiples of similar companies or transactions to perform a business valuation . It can be applied wherever you can collect sufficient and reliable data points to determine the value of a business based on the implied valuation multiples of similar businesses or transactions.

This valuation method uses the implied valuation multiples from publicly traded companies at the stock market to value our target business. We analyze the valuation multiples of a suitable peer group to determine the appropriate valuation multiple (or range) which should be applied to the company we seek to value. If the stock market values peer companies in the range of 4.5x – 5.5x EV/EBITDA, a company with $1m in EBITDA would be valued between $4.5 – $5.5m.

The following illustration shows the valuation process.

Most frequently used multiples are P/E ratio, EV/Sales, EV/EBITDA, EV/EBIT and Price to Book ratio as well as industry-specific valuation metrics such as EV/subscriber, EV/user, etc. In many cases preference to the EV/EBITDA multiple will be given as the EV/EBITDA multiple includes the cost structure (opposite to the EV/Sales multiple) but is not affected by the company’s depreciation policy (such as the EV/EBIT multiple) or financing structure (P/E ratio, Price to Book Ratio).

Important to note is that the quality of a stock market multiples analysis stands and falls with the selection of suitable comparable companies within the peer group. Each company needs to be comparable in terms of activities, geography, industries, customer segments, size, etc. Only the best comparable peer companies will make this analysis powerful. In reality, many times peer companies are not truly comparable which limits the explanatory power of this analysis.

Pros/Cons of the Stock Market Multiples Valuation Method

Also known as the precedent transaction method which involves looking up historical transaction data mostly from non-public transaction to find out at which valuation multiples similar companies have been bought or sold. This method relies heavily on private transaction data being publicly available in order to have the required data points for our analysis. Private transactions normally are biased towards Small and Medium-Sized companies (if a company gets bigger, it is more likely that it will become publicly listed).

This valuation method works very similarly to the stock market valuation method. The main difference is the recent transaction analysis bases on private transaction data rather than the latest trading multiples.

Pros/Cons of the Recent Transactions Valuation Method

Cost and Asset Approach

The cost approach determines the value of a business by the cost it takes to reproduce or replace it. A close relative of the cost approach is the asset-based approach which determines the value of a business by summing up all of the business’ assets.

Replacement cost analysis simply adds up all costs which are needed to reproduce or replace a business (or an asset). The analysis can especially be useful when having to make a buy or build decisions. Especially when looking to acquire a company in a foreign market to achieve a market entry, it can be worthwhile to evaluate how much it would take to build a company from scratch. The result of this analysis will impact the value a buyer is willing to pay for a target company.

The analysis is simple to perform as below illustration shows:

Pros/Cons of the Replacement Cost Analysis

The Net Asset Valuation Method determines the value of a company based on the value of the net assets (equal to the equity value) on its balance sheet.  The analysis with the book values of each asset (normally booked at cost). Each asset book value then is adjusted to reflect the fair market value of the asset. The important concept to recognize is that the asset values can be significantly different from the asset’s original acquisition cost contained in the balance sheet. Take for example a piece of land purchased three years ago for $1 million, the same land might be worth twice or even three times more based on current fair market value. If the value adjustments result in a capital gain, a deferred tax liability may also be created which needs to be deducted as a liability.

This approach is mostly used for valuing holding companies, operating companies that are considering liquidation (sale or merger) and asset-heavy companies such as real estate investments, financial institutions, and natural resources companies. The main disadvantage is that the valuation does not consider the future earning potential of the company. Also, valuing a company’s intangible assets like intellectual property, trademarks and goodwill can be complex and may be over-or understated.

Net asset value analysis depends heavily on the underlying valuation scenario, especially:

• Liquidation scenario: Assets are valued as if they will be liquidated which in most cases results in heavy liquidation discounts to be applied.
• Going concern scenario : Assets are valued at their normal market values assuming the business keeps operating which normally leads to a higher valuation result than the liquidation scenario.

Let us look at the following example of a net asset value analysis for a restaurant which is made in order to hand-over the business from the current owner to his successor.

How does this work? Here we look at a situation where we expect the restaurant to keep operating. First, all assets are reviewed and adjusted to reflect their fair market values. We will leave cash unchanged as it already reflects its current value. Accounts Receivable is adjusted to reflect the amount determined to be uncollectible, in our example the amount is $100,000. Inventory is also adjusted to remove the obsolete inventory amounting to $100,000. For Fixed Assets, accumulated depreciation becomes irrelevant and is removed as we focus on the asset’s market value. The building is undervalued in the company’s balance sheet compared to the netted value by $1,000,000 while the kitchen equipment is overvalued by $487,500 net of accumulated depreciation. Capital gains of $1,562,500 trigger a deferred tax liability of $312,500 (at a 20% tax rate).

The next step is to add up the fair market values of the assets and deduct total liabilities. The restaurant has total assets at a fair market value of $7,812,500 and total liabilities of $4,812,500. The value of the company using the net asset value approach is $3,000,000.

Pros/Cons of the Net Asset Valuation Method

Above we have presented the most common valuation methods used for business and asset valuation purposes. As you can you see there is a wide range of suitable valuation methods available to choose from. The choice of the appropriate valuation methods not only depends on the company’s situation but also on the availability and accuracy of required data. As each valuation method will value the company from a different angle and therefore leads to different results, it is important to combine select valuation methods. By using the valuation results as data points it’s possibly better to triangulate the range where a reasonable business valuation should lie within.

In general, preference should be given to business valuation methods using fundamental analysis such as e.g. the DCF Method as this can best reflect the value to be derived from the expected cash flows of a business and can also explain exactly from where the value should come from. However, the valuation will not have much meaning unless it is cross-checked with other valuation methods. Cost-based valuation methods are another option to choose from. However, they lack the income aspect and therefore neglect an important aspect when trying to truly understand the sources of value.

No single valuation approach is best for every company for each scenario. Some business valuation methods are fairly easy and simple to apply while others are more complex to use. So try to figure out which valuation methods are most suitable to use for your own specific business valuation the next time you need to decide how to value a business.

Whether you are an analyst building a financial model for a particular industry or valuing stock for personal investments, a good source of valuation spreadsheets for valuation is available at eFinancialModels . Our models are used by entrepreneurs, investors, CEOs, CFOs, consultants from all parts of the world including countries such as the USA, Canada, UK, Australia, New Zealand Germany, France, the Netherlands, Mexico, India, China, Japan, and many more. If you’re looking for financial model templates specifically for valuation purposes, please feel free to browse our selection below:

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What is Valuation?

Reasons for performing a valuation, 1. buying or selling a business, 2. strategic planning, 3. capital financing, 4. securities investing, company valuation approaches, method 1: dcf analysis.

• Method 2: comparable company analysis (“comps”)

Method 3: precedent transactions

Football field chart (summary), more valuation methods, additional resources, valuation overview.

The process of determining the present value of a company or an asset

Valuation refers to the process of determining the  present value of a company, investment or an asset. There are a number of common valuation techniques, as described below. Analysts who want to place a value on an asset normally look at the prospective future earning potential of that company or asset.

By trading a security on an exchange, sellers and buyers will dictate the market value of that  bond  or stock. However,  intrinsic value is a concept that refers to a security’s perceived value on the basis of future earnings or other attributes that are not related to a security’s market value. Therefore, the work of analysts when performing a valuation is to know if an investment or a company is undervalued or overvalued by the market.

Key Highlights

• Valuation is the process of determining the theoretically correct value of a company, investment, or asset, as opposed to its cost or current market value.
• Common reasons for performing a valuation are for M&A, strategic planning, capital financing, and investing in securities.
• The three most common investment valuation techniques are DCF analysis, comparable company analysis, and precedent transactions.

Valuation is an important exercise since it can help identify mispriced securities or determine what projects a company should invest. Some of the main reasons for performing a valuation are listed below.

Buyers and sellers will normally have a difference in the value of a business. Both parties would benefit from a valuation when making their ultimate decision on whether to buy or sell and at what price.

A company should only invest in projects that increase its net present value . Therefore, any investment decision is essentially a mini-valuation based on the likelihood of future profitability and value creation.

An objective valuation may be useful when negotiating with banks or any other potential investors for funding. Documentation of a company’s worth, and its ability to generate cash flow, enhances credibility to lenders and equity investors.

Investing in a security, such as a stock or a bond, is essentially a bet that the current market price of the security is not reflective of its intrinsic value . A valuation is necessary in determining that intrinsic value.

When valuing a company as a going concern, there are three main valuation techniques used by industry practitioners: (1) DCF analysis , (2) comparable company analysis, and (3) precedent transactions. These are the most common methods of valuation used in  investment banking , equity research, private equity, corporate development, mergers & acquisitions ( M&A ), leveraged buyouts ( LBO ), and most areas of finance.

As shown in the diagram above, when valuing a business or asset, there are three different approaches one can use. The asset approach calculates the fair market value of individual assets, often including the cost to build or cost to replace. The asset approach method is useful in valuing real estate, such as commercial property, new construction, or special-use properties. 

Next is the income approach, with the discounted cash flow (DCF) being the most common. A DCF is the most detailed and thorough approach to valuation modeling. 

The final approach is the market approach, which is a form of relative valuation and is frequently used in the finance industry. It includes comparable company analysis and precedent transactions analysis.

Discounted cash flow (DCF)  analysis is an  intrinsic value  approach where an analyst forecasts a business’s unlevered  free cash flow into the future and discounts it back to today at the firm’s weighted average cost of capital ( WACC ).

A DCF analysis is performed by  building a financial model  in Excel and requires an extensive amount of detail and analysis. It is the most detailed of the three approaches and requires the most estimates and assumptions. Therefore, the effort required to preparing a DCF model may also often result in the least accurate valuation due to the sheer number of inputs. However, a DCF model allows the analyst to forecast value based on different scenarios and even perform a sensitivity analysis.

For larger businesses, the DCF value is commonly a sum-of-the-parts analysis, where different business units are modeled individually and added together.

Method 2: comparable company analysis (“comps”)

Comparable company analysis  (also called “trading comps”) is a relative valuation method  in which you compare the current value of a business to other similar businesses by looking at trading multiples like P/E,  EV/EBITDA , or other multiples. 

The “comps” valuation method provides an observable value for the business, based on what other comparable companies are currently worth. Comps is the most widely used approach, as the multiples are easy to calculate and always current. The logic follows that if company X trades at a 10-times P/E ratio, and company Y has earnings of $2.50 per share, company Y’s stock must be worth $25.00 per share (assuming the companies have similar risk and return characteristics).

Precedent transactions analysis  is another form of relative valuation where you compare the company in question to other businesses that have recently been sold or acquired in the same industry. These transaction values include the take-over premium included in the price for which they were acquired.

The values represent the entire value of a business and not just a small stake. They are useful for M&A transactions but can easily become dated and no longer reflective of current market conditions as time passes.

Investment bankers will often put together a  football field chart  to summarize the range of values for a business based on the different valuation methods used. Below is an example of a football field graph, which is typically included in an  investment banking pitch book .

As you can see, the graph summarizes the company’s 52-week trading range (it’s stock price, assuming it’s public), the range of prices equity research analysts have for the stock, the range of values from comparable valuation modeling, the range from precedent transaction analysis, and finally the DCF valuation method. The orange dotted line in the middle represents the average valuation from all the methods.

Another valuation method for a company that is a going concern is called the  ability-to-pay analysis . This approach looks at the maximum price an acquirer can pay for a business while still hitting some target. For example, if a private equity  firm needs to hit a  hurdle rate  of 30%, what is the maximum price it can pay for the business?

If the company does not continue to operate, then a  liquidation value  will be estimated based on breaking up and selling the company’s assets. This value is usually very discounted as it assumes the assets will be sold as quickly as possible to any buyer.

DCF Terminal Value

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Rules of Thumb Business Valuation Methods Explained

Colin McCrea

7 min. read

Updated October 24, 2023

The rule of thumb has a long history in the business world especially when it comes to valuing business interests in the community. In order to avoid formal valuation report costs, shareholders utilize benchmarks of the industry and rules of thumb to estimate the ballpark values of their interests. This approach acts according to different scenarios where the rule of thumb may be more or less effective. 

This article will cover all about the rule of thumb business valuation approaches, when to use them, and their pros and cons.

Rules of thumb and business valuation 

Valuation techniques can materially undervalue or overvalue business interests. It enables shareholders to estimate the rough value of their business quickly and cost-effectively. However, in scenarios where you have to estimate a more precise and technical value like estate planning, litigation, and transactions—rules of thumb do not provide an accurate value.

What is a rule of thumb business valuation approach?

The rule of thumb is a business valuation method that is based on common sense and experience. It is a general principle that is regarded as approximately accurate but not meant to be scientifically correct. For estimating the value of a business, the process involves applying a multiple to an economic benefit of a specific industry. Metrics such as discretionary cash flow or business revenue are used. 

A company’s goodwill might be worth 2x more than the discretionary cash flow, or the accounting practice’s value might be worth 1 to 1.35x the annual revenue + work-in-progress (inventory). The rule of thumb traditionally originated from the combination of observations, real-world market transactions, hearsay, and experience. 

When to use the rules of thumb for a business valuation? 

This approach usually values a company depending on multiples from the specific industry such as cash flows, revenues, EBITDA, and others. Even though this is a valid method, you cannot use only this approach while valuing a business. The reason for this is that the rule of thumb only gives an estimated valuation that is specific to the industry. Different markets will have several different variations in multiples from the rule of thumb. 

Many other factors affect the valuation of a business . If two businesses are in the same industry, it is not necessary that you can compare them with each other as there can be differences in the business practices, customer base, cost structures, etc. A business valuation through the rule of thumb approach is generally developed over a long time. But, companies and industries keep evolving and growing and applying old value factors can give you an incorrect estimate. 

That said, business owners can still benefit from a rule of thumb as it can provide insights on a ballpark estimate for the value of a company. It can also suggest special purchasers, those who willingly pay a higher price for a company, by benefitting from the perceived synergies of purchasers. 

For many business owners, getting a formal valuation is worth the investment. Some reasons why include needing a more detailed picture of your company’s value, submitting taxes, outlining employee stock option plans, or presenting to investors or creditors.

• Rules of thumb in business valuation

The general rules of thumb are a good measure for certain industries, and where your company may stand compared to other industry peers . So seeing how the metrics in key industries stack up against each other may give you insight into whether your company is performing well or not. 

Many companies come from a variety of industries. While companies are all different, getting a valuation is the same process regardless of the industry. To explain further, let’s take a look at this list of the most profitable industries (according to a recent writeup from Yahoo Finance ).  

• Software (system and application)
• Computer peripherals
• Drugs and Pharmaceuticals
• Oil and Gas
• Household products
• Computer Services
• Healthcare Support Services
• Life Insurance
• Semiconductor Industry
• Information

In order to conduct the valuation for companies in these industries, there are several calculations that valuation analysts use. The following formulas are used to calculate the various aspects of the business valuation:

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Sales Multiples

Where Net Sales = Annual Gross Sales, net of returns and discounts allowed, if any.

The sales multiplier is the most used valuation metric, as it takes your total sales and compares them to other companies and their sales multiples. The majority of small and medium-sized companies used this metric for their valuation.

EBITA Multiple 

Where EBITDA = Operating Profit + Depreciation & Amortization

EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortization. This is commonly used for finding the value of medium to large businesses. Investors are able to compare your business to others in the same industry by taking away the expenses that skew a fair comparison.

SDE Multiple

Where SDE = Operating Profit + Depreciation + Amortization + Owner’s Compensation

SDE stands for seller’s discretionary earnings. This is the most common multiple to value small businesses. By using this, someone who is looking to acquire your business lets them know how much they would earn if they worked in the company. 

Gross Profit Multiple

Where Gross Profit = Net Sales – Cost of Goods Sold

Obtaining the gross profit can work best as a valuation method for companies that are losing money, but their gross profit serves as a good indicator for their total value.

Rule of thumb table

Given below is a table that describes the sales multiple, EBITDA multiple, SDE multiple, and profit multiple of various businesses. Have a look at it to understand more about the figures. 

Pros and cons of the rule of thumb valuation approach 

The rule of thumb valuation approach has several pros, but also cons. It’s important to know why this approach can be helpful but also why it won’t work for certain situations.

• The approach is straightforward, simple, and fast to apply
• You can save money and time to determine the value
• There are times that the rules of thumb are noted in buy-sell agreements to assist concerned parties in seeing the value they would receive in the transferral of equity
• The approach can have hidden assumptions concerning the risks and profitability of a company, which can lead to an incorrect valuation and a drop in price
• It does not reflect the essential items in the balance sheet (such as debt levels, real estate, non-operating assets, or cash on hand)
• Due to one-time shortfalls, the rule of thumb can drive wrong conclusions and estimations. 
• Examples of rule of thumb valuation

Let us take an example to understand the rule of thumb better. One rule in this approach is that insurance agencies tend to sell for 1 to 1.5x their net commission revenue. This generates an MVIC (market value of invested capital) basis. Here are two scenarios in which the rule of thumb can play out:

Base scenario

An insurance agency has a revenue of $2m. It has $600,000 in EBITDA. The valuation can be $2.4m MVIC. This falls within the spectrum of 1-1.5x of the net commission revenue rule of thumb.

Low-profit scenario

The agency revenue is steady at $2m, but the earnings before interest, tax, depreciation, and amortization drop to $360,000. The value is close to $1.4m. This value is less than the rule of thumb guidelines and settled in the spectrum of $2m to $3m. This means that you would have overpaid for the company.

Get professional advice for valuation 

Business shareholders have a unique tool to give a rough value of their business interests. This is an opportunity for them to estimate the ballpark value of the business fast and cost-efficiently. Shareholders can use the method in limited scenarios, be cautious, and not only rely on the rule of thumb valuation. 

Keep in mind that it is vital to know and understand the limitations and inner workings of the valuation method. It is best that before you use the rule of thumb valuation as your only estimation method, you should consult a professional for advice .

Colin is the CVA of Eqvista , leading in the valuation section of private companies, and specializing in the space around company valuation, investments, VC funding, seed funding, cap table, equity management.

Table of Contents

• Rules of thumb and business valuation 
• Pros and cons of the rule of thumb valuation approach 
• Get professional advice for valuation 

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What Is Valuation?

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What Is Valuation? How It Works and Methods Used

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Valuation is the analytical process of determining the current or projected worth of an asset or company. Many techniques are used for doing a valuation. Among other metrics, an analyst placing a value on a company looks at the business's management, the composition of its capital structure , the prospect of future earnings, and the  market value of its assets.

Fundamental analysis is often employed in valuation although several other methods may be employed such as the capital asset pricing model (CAPM) or the dividend discount model (DDM).

Key Takeaways

• Valuation is a quantitative process of determining the fair value of an asset, investment, or firm.
• A company can generally be valued on its own on an absolute basis or a relative basis compared to other similar companies or assets.
• Several methods and techniques can be used to arrive at a valuation, each of which may produce a different value.
• Valuations can be quickly impacted by corporate earnings or economic events that force analysts to retool their valuation models.
• Valuation is quantitative in nature but it often involves some degree of subjective input or assumptions.

Investopedia / Mira Norian

A valuation can be useful when you're trying to determine the  fair value of a security determined by what a buyer is willing to pay a seller assuming that both parties enter the transaction willingly. Buyers and sellers determine the market value of a stock or bond when a security trades on an exchange.

The concept of intrinsic value refers to the perceived value of a security based on future earnings or some other company attribute. It's unrelated to the market price of a security and this is where valuation comes into play. Analysts do a valuation to determine whether a company or asset is overvalued or undervalued by the market.

Types of Valuation Models

• Absolute valuation models  attempt to find the intrinsic or "true" value of an investment based only on fundamentals. You would focus only on things such as dividends, cash flow, and the growth rate for a single company. You wouldn't worry about any other companies. Valuation models that fall into this category include the dividend discount model, discounted cash flow model, residual income model, and asset-based model.
• Relative valuation  models operate by comparing the company in question to other similar companies. These methods involve calculating multiples and ratios such as the price-to-earnings multiple and comparing them to the multiples of similar companies.

The original company might be considered undervalued if the P/E is lower than the P/E multiple of a comparable company. The relative valuation model is typically a lot easier and quicker to calculate than the absolute  valuation  model. This is why many investors and analysts begin their analysis with this model.

Types of Valuation Methods

You can do a valuation in various ways.

Comparables Method

The comparable company analysis  looks at companies that are in size and industry and how they trade to determine a fair value for a company or asset. The past transaction method looks at past transactions of similar companies to determine an appropriate value. There's also the asset-based valuation method which adds up all the company's asset values to get the intrinsic value assuming that they were sold at fair market value.

A comparables approach is often synonymous with relative valuation in investments.

Sometimes doing all these and then weighing each is appropriate to calculate intrinsic value but some methods are more appropriate for certain industries. You wouldn't use an asset-based valuation approach to valuing a consulting company that has few assets. An earnings-based approach like the DCF would be more appropriate.

Discounted Cash Flow Method

Analysts also place a value on an asset or investment using the cash inflows and outflows generated by the asset. This is called a discounted cash flow  (DCF) analysis. These cash flows are discounted into a current value using a discount rate which is an assumption about interest rates or a minimum rate of return assumed by the investor.

DCF approaches to valuation are used in pricing stocks such as with dividend discount models like the Gordon growth model.

The firm analyzes the cash outflow for the purchase and the additional cash inflows generated by the new asset if a company is buying a piece of machinery. All the cash flows are discounted to a present value and the business determines the net present value (NPV). The company should invest and buy the asset if the NPV is a positive number.

Precedent Transactions Method

The precedent transaction method compares the company being valued to other similar companies that have recently been sold. The comparison works best if the companies are in the same industry. The precedent transaction method is often employed in mergers and acquisition transactions.

The earnings per share  (EPS) formula is stated as earnings available to common shareholders divided by the number of common stock shares outstanding. EPS is an indicator of company profit because the more earnings a company can generate per share the more valuable each share is to investors.

Analysts also use the price-to-earnings (P/E) ratio for stock valuation. This is calculated as the market price per share divided by EPS. The P/E ratio calculates how expensive a stock price is relative to the earnings produced per share.

An analyst would compare the P/E ratio with other companies in the same industry and with the ratio for the broader market if the P/E ratio of a stock is 20 times earnings. Using ratios like the P/E to value a company is referred to as a multiples-based or multiples approach valuation in equity analysis. Other multiples such as EV/EBITDA are compared with similar companies and historical multiples to calculate intrinsic value.

It's easy to become overwhelmed by the number of valuation techniques available to investors when you're deciding which valuation method to use to value a stock for the first time. Some valuation methods are fairly straightforward. Others are more involved and complicated.

Unfortunately, no one method is best suited for every situation. Each stock is different and each industry or sector has unique characteristics that can require multiple valuation methods. Different valuation methods will produce different values for the same underlying asset or company which can lead analysts to employ the technique that provides the most favorable output.

What Is an Example of Valuation?

A common example of valuation is a company's market capitalization. This takes the share price of a company and multiplies it by the total shares outstanding. A company's market capitalization would be $20 million if its share price is $10 and the company has two million shares outstanding.

How Do You Calculate Valuation?

You can calculate valuation in many ways. They'll differ based on what's being valued and when. A common calculation in valuing a business involves determining the fair value of all of its assets minus all of its liabilities. This is an asset-based calculation.

What Is the Purpose of Valuation?

The purpose of valuation is to determine the worth of an asset or company and compare that to the current market price. This is done for a variety of reasons such as bringing on investors, selling the company, purchasing the company, selling off assets or portions of the business, the exit of a partner, or inheritance purposes.

Valuation is the process of determining the worth of an asset or company . It's important because it provides prospective buyers with an idea of how much they should pay for an asset or company and how much prospective sellers should sell for.

Valuation plays an important role in the M&A industry as well as the growth of a company. There are many valuation methods, all of which come with their pros and cons.

UNDER30CEO. " Absolute Valuation Formula ."

CFI Education. " Relative Valuation Models ."

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Using a Business Valuation for a Business Plan

Mar 5, 2024 | Business Appraisal , Business Plan , Business Valuation

Whether you are starting , buying , expanding , or selling a business , it is important to have a strong business plan. A business plan is a document that outlines a business’s goals, strategies, operations, and financial projections. This document serves as a roadmap to help business owners succeed. If you are looking to create or strengthen a business plan, it is helpful to obtain a business valuation . As part of a business valuation for a business plan, operators gain crucial insights into a business’s risks, opportunities, and financial health. 

Peak Business Valuation is happy to help! As a business appraiser, Peak values thousands of businesses throughout the United States. We can provide you with a business valuation for a business plan. In addition, Peak Business Valuation can discuss any questions you may have on business plans and valuing a business. Start now by scheduling a free consultation with Peak Business Valuation below! 

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Creating a Business Plan

Creating a business plan involves several steps. This can include conducting market research, setting goals, outlining the specifics of products and services, creating financial projections, etc… Business owners can enhance this process by receiving a business valuation for a business plan. During a business valuation, valuation experts analyze the financial standing of your business. In addition, business appraisers conduct a thorough risk assessment and provide business owners with a valuation report. 

In the following paragraphs, we discuss how to use a business valuation to create a strong business plan. For more information, see Creating a Strong Business Plan . 

Understanding the Value of a Business

First, understanding the true value of a business helps operators make decisions about resource allocation, growth opportunities, and potential risks. This also ensures that your goals are aligned with your business’s current value. As such, a business valuation provides a strong foundation for your business plan. To learn more, schedule a free consultation with Peak Business Valuation ! 

Setting Realistic Goals

Next, to set realistic financial goals, you need to understand the current value of your business. As such, a business valuation for a business plan plays an important role in goal setting. In addition to calculating a business’s fair market value, business appraisers assess the strengths and weaknesses of a business. With these insights, you can create an effective strategy to maximize the value of a business . Read How to Increase the Value of Your Business to learn more. 

Attracting Investors and Securing Financing

For many businesses, attracting investors and securing financing for a small business is essential. Obtaining a business valuation provides investors and lenders with a clear understanding of your company’s potential. This shows the feasibility of your business to stakeholders and demonstrates transparency and financial diligence. As such, receiving a business valuation for a business plan makes it more compelling to potential financiers. If you are seeking financing for a small business, consider securing an SBA loan . To learn more, see SBA Loans or SBA Financing .

As a professional business appraiser, Peak Business Valuation works with over 90 SBA lenders across the country. We are happy to connect you with an experienced SBA lender that meets your needs! Additionally, Peak can provide you with a business valuation and discuss any questions you may have on business valuations and creating a business plan. Get started today by scheduling a free consultation with Peak Business Valuation below! 

Minimizing Risks 

Furthermore, using a business valuation for a business plan helps identify and mitigate risks. The valuation process analyzes the strengths, weaknesses, risks, and opportunities associated with a business. This information helps business owners develop strategies to overcome challenges. In addition, understanding the weaknesses of a business allows operators to make adjustments to increase the business’s value. To learn more about navigating risks, see Risks When Buying a Business . 

Allocating Resources

As mentioned before, the valuation report provides valuable insights into a business’s strengths and weaknesses. This information allows you to allocate resources where they will have the most impact. For example, if the valuation report shows that your business lacks a strong online presence, you can allocate resources toward developing your website. As such, receiving a business valuation for a business plan can help you optimize resource allocation and improve a business’s efficiency.  

Strategic Decision-Making and Exit Planning

Finally, business valuations are crucial for strategic decision-making and exit planning . The valuation report provides a data-driven summary of your company’s fair market value and potential growth opportunities. This helps you understand how various strategies impact your business’s value. In addition, you can use these insights to develop a detailed exit plan whether you are selling the business , gifting it to family members , or making it public. As such, with a business valuation for a business plan, you can make informed choices that align with your business’s long-term objectives. If you have any questions, reach out to Peak today! See How Exit Planning Affects Your Business to learn more. 

If you are looking to start, buy , expand , or sell a business , it is vital to have a strong business plan. Business valuations are helpful whether you are creating a new business plan or strengthening your current one. As part of a business valuation, you will learn the value of a small business and discover the associated risks and opportunities. These insights can help you make informed decisions to maximize the value of a business . 

Peak Business Valuation , business appraiser, can help you with your business plan through a business valuation. We are happy to provide you with a business valuation for a small business and discuss any questions you may have about a business valuation for a business plan . Schedule a free consultation with Peak Business Valuation to get started!

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The Importance of Business Valuation

Business owners spend considerable time and energy trying to enhance company value by developing growth plans with well-defined goals.  These plans are designed to maximize value over time, but it’s hard to achieve those goals without knowing where to begin.

Not only do owners need to understand what their business is worth today, they also need to know what supports and drives that value.   Far too often, owner overconfidence or apathy causes this step to either be neglected or downplayed, or at a minimum, based on incomplete data or conjecture.  In this case, a valuation usually serves as a reality check for owners with a biased or uninformed viewpoint on what their business is worth.

Why would a business owner want a valuation? 

The traditional answer is that valuations are needed to resolve tax or legal issues.  However, valuations are actually performed for a myriad of reasons, including but certainly not limited to selling or acquiring a business.  In the cases of death, disability, disaster or divorce, valuations are needed to equitably determine the business assets according to terms spelled out in legal filings.

Valuations are often needed when gifting or donating company stock as part of a charitable contribution, in resolving IRS or shareholder disputes, or when converting a C-corporation to an S-corporation.  There could be requirements in a buy/sell, partnership or shareholder agreement that necessitates a business valuation.

In addition, owners would generally perform a valuation when attempting to raise strategic capital or obtaining a Small Business Association (SBA) loan.  Implementing an Employee Stock Ownership Plan (ESOP) would certainly necessitate an initial and annual valuation.

Moreover, a formal business valuation can help to reconcile perceived opinions on value, and coupled with a marketability analysis, it can help a business owner determine relative value in the marketplace.

How does the business valuation process work? 

The assessment of value is indeed an art form as much as it is a science.  Business valuation is a process and a set of procedures used to estimate the economic value of an owner’s interest in a business.  An accurate valuation of a closely held business is an essential tool for a business owner to assess both opportunities and opportunity costs as they plan for future growth and eventual transition.  It provides either a point-in-time assessment of relative value for an owner, or perhaps the price a buyer would be willing to acquire the business.

On its face, business valuation is actually a relatively simple and straightforward concept.  A qualified professional first analyzes the subject company’s financial statements and considers comparable transactions, industry ratios and other quantitative and qualitative information.  Then, applicable adjustments are made to align the subject company to an industry standard or benchmark.  The result is a reasonable assessment of fair value, usually performed under the  Uniform Standards of Professional Appraisal Practice (USPAP).

Despite the benefits, however, many business owners are apprehensive about what to expect when going through the valuation process.  In some cases, valuations can expose areas of the business which actually take away from value, such as weak financial and accounting controls, under-performing assets and weaker operating ratios relative to its peer group.   The entire valuation process can provide an overview of strengths and weaknesses of the reviewed company.

What are the key considerations for the business valuation?

The business valuation professional will first consider the purpose and objective of the valuation.  They will then look at the nature and background of the business, its products and services, as well as the industry life cycle, economic and political environment.  Unique factors are then considered, including customer relationships, executive compensation, as well as excess assets, working capital, and liabilities.

Considerations which could have a profound influence on value include goodwill or other intangible assets, the dependency on an owner or key employee(s), diversity of the customer base, market position and the competitive landscape of the industry.

There are three widely accepted fundamental methods used in valuing closely held business interests, the asset, income, and market approach.  The methods most useful in determining final value will depend on several factors, including the purpose of the valuation and the type of company being valued.

What are the Exit & Estate planning considerations for retirement?

A business valuation is an essential component of the estate and tax planning process for owners and their families.  Since the value of the business often accounts for the bulk of the owner’s net worth, determining a reasonable value is not only critical to retirement planning following the exit from the business, but also the groundwork required to both protect and transfer that wealth to the next generation.

Statistics suggest that most owners don’t do business planning or even plan for their own exit, and as a result, many transactions leave sellers feeling somewhat unfulfilled.  If used correctly, however, a thorough valuation can provide that very important starting point in strategic growth planning, as well as some important visibility for an owner contemplating the long term.  It can also serve as a meaningful tool as part of a business “gap analysis” to help identify and eliminate the various anchors to value growth during the exit planning process.  A valuation incorporated into a comprehensive business assessment should yield higher business growth over time, as well as higher terminal values and selling prices.

Jeffrey Elder, MBA – IBBA Certified M&A advisor, Texas Certified Business Broker, International Business Exchange, Austin Texas

Eric C. Boyce, CFA – Chief Executive Officer, BKA Business Consulting, LLC, Cedar Park, Texas (home of the  BizVue tm  Five Pillars of Value Business Assessment platform)

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Business Valuation is a comprehensive process used to determine the economic value of a whole business or company unit, based on factors like its asset value, market position, and future earnings potential.

A business valuation involves assessing various elements of the business to estimate its selling price or value for different purposes, such as investment analysis, business sales, or mergers and acquisitions. For entrepreneurs and business owners, understanding business valuation is key to making informed decisions about their company’s future and financial health.

Valuation Methods

Asset-based approach (also known as book valuation).

The Asset-Based Approach, often referred to as “Book Valuation,” focuses on the value of a company’s assets. It involves totaling the value of all the company’s tangible and intangible assets and then subtracting its liabilities. This approach is most applicable to companies with significant physical assets.

Income Approach (Also Known as Discounted Cash Flow (DCF) Analysis)

The Income Approach, frequently termed as “Discounted Cash Flow (DCF) Analysis,” estimates a company’s value based on its expected future cash flows. These cash flows are then discounted back to their present value, using a discount rate that reflects the risk of the cash flows. This method is particularly useful for companies with stable and predictable cash flows.

Market Approach

The Market Approach values a company by comparing it to similar companies that have been sold or are publicly traded. This approach is especially relevant for businesses operating in industries with a large number of comparable companies and transactions.

Hybrid Approach

A Hybrid Approach combines elements of the asset-based, income, and market approaches to provide a more comprehensive valuation. This method is particularly useful when each individual approach has limitations due to the unique characteristics of the business being valued. For instance, a business might have significant physical assets (favoring an asset-based approach), stable cash flows (suitable for the income approach), and comparable companies in the market (aligning with the market approach). By integrating these methods, the hybrid approach offers a balanced and nuanced valuation, considering multiple facets of the business’s value.

Application in Business Valuation

In practice, the choice of valuation method depends on the nature of the business, the purpose of the valuation, and the availability of data. For instance, startups with limited financial history might not find the income approach as effective, whereas established companies with significant physical assets might lean towards the asset-based approach. The hybrid approach can be particularly useful in complex valuation scenarios where a single method may not capture the full picture of a company’s value.

Using a combination of these methods can provide a more rounded and accurate estimation of a company’s worth, essential for strategic decision-making, investment analysis, and transactions such as mergers and acquisitions.

Valuation Professionals:

Certified Valuation Analysts (CVAs), Accredited Senior Appraisers (ASAs), and other valuation professionals play a crucial role in the business valuation process. They provide expertise, objectivity, and standardized methods to ensure a fair and accurate valuation, especially in complex scenarios or legal proceedings.

Frequently Asked Questions

• When should a business consider getting a valuation?

A business should consider getting a valuation in several scenarios, such as when contemplating a sale or merger, seeking investment, planning for taxes, or during legal proceedings involving asset division. It’s also useful for strategic planning and understanding the financial growth or trajectory of the company.

• How can the choice of valuation method impact the estimated value of a business?

The choice of valuation method can significantly impact the estimated value of a business as each method focuses on different aspects of value. For instance, the asset-based approach might yield a different value compared to the income or market approach, as it focuses on tangible assets rather than earnings potential or market comparables. The appropriate method depends on the nature of the business and the purpose of the valuation.

• Why is it important to engage professional valuation services?

Engaging professional valuation services is important to ensure accuracy, objectivity, and compliance with legal and financial standards. Professional valuators have the expertise to apply the most suitable valuation methods and consider all relevant factors, resulting in a more reliable and credible valuation. This is especially crucial in high-stakes situations like legal disputes, significant business transactions, or complex financial planning.

• What is a valuation multiple and how is it used in business valuation?

A valuation multiple is a financial metric used to estimate a business’s market value relative to a key financial statistic, such as earnings, sales, or assets. Common examples include price-to-earnings (P/E) ratio, enterprise value-to-sales (EV/Sales), and enterprise value-to-EBITDA (EV/EBITDA). These multiples are derived from market comparisons and are used to value a business by applying the multiple to the corresponding financial metric of the business being valued. They are particularly useful in the market approach to business valuation.

• Can a brand-new company be valued, and what factors contribute to its valuation?

In most cases, a brand-new company without operational history or financials may not have a significant established value. However, its potential value can be determined based on factors such as the entrepreneur’s experience, the uniqueness of the business idea, market potential, intellectual property, and anticipated future cash flows. While it’s challenging to assign a concrete value to a new company, these factors can provide investors or founders with an initial estimation of its potential worth.

• How is the valuation of a brand-new company typically determined?

The valuation of a brand-new company is often determined by projecting its future cash flows and then discounting them to their present value using an appropriate discount rate (as in the Discounted Cash Flow Analysis). This method is predicated on the expectation that the company will generate positive cash flows in the future. Other factors, like market demand for the product or service, the strength of the business plan , and the experience of the management team, also play a crucial role in this valuation process. For very early-stage companies, valuation may also be influenced by comparable transactions in the industry or by the amount of capital the founders need and the amount of equity they are willing to give up.

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