Best Practices for Business Valuation Methods

Business valuation is the deliberate financial procedure carried out to measure the worth of a company’s business. When companies desire to know the value of their businesses and how much it measures in an open market, they conduct business valuation. 


Why companies carry out business valuation?

There are many reasons companies conduct business valuation. Some of which include:

✓     To measure business growth over time

✓     To place a bearing on the results of new quality control and salient changes made in the businessorganization

✓     Most commonly, to value a business during merger, acquisitions, andtakeovers.


When business valuation is carried out, it is not enough to just know the worth of an organization. It is equally important to know the dynamics involved and the suitability of each valuation method. Our last statement suggests that the method you use in evaluating your business will determine to a large extent, the result you will get. 

How then can you carry out efficient business valuation? What methods are used for business valuation and which is best?


Different methods of business valuation

Over the years, various organizations have used different methods for business valuation. While some focus on the intrinsic and potential value of a business, others measure its outright wealth and assets. A third class, on the other hand, looks at the competitionto determine business value!

Here are 3 different methods of business valuation:

1.    Market Capitalization:This method of business valuation is based on share value and the stockmarket. For this method, the share value of a company’s stock is multiplied by outstanding shares. 

If a company’s share is valued at $20 having 1 million outstanding shares, such a company will be valued at $20 million by this method. Market capitalization is inadequate because it does not measure fixed and capital asset of a business.


2.    Time Revenue Valuation:In this business valuation method, the standard or frequent revenue of a company is multiplied witha reasonable time span. 


For instance, if a company makes $50,000 a year, this method will value it at $200,000 in 4 years.Time revenue valuation method isbased highly onexpectation. Therefore, business goodwill may be damaged or a rising competition may disrupt the profitmargin. Time Revenue Valuation can also be called earnings multiplieras both are equally uncertain.


3.     Business Book Value:Business evaluation by book value is, on the other hand, very specific. It involves the subtraction of the total liability of a company’s liabilities from its assets.  


Most popular business valuation methods

From all three methods mentioned above, it is apparent that Business Book Value is most likely to provide accurate results when performing a thorough business valuation. 

But the methods that are frequently used for business valuation include - 

  1. Asset Approach

Asset approach is based on an economic principle of valuation. It is determined by evaluating how much it will cost to create another business like the one which is being valued. It doesn’t look at the assets or liabilities alone. It values the experience a companyhas, the goodwill it has created and what it will take to build such an establishment from scratch.

Asset approach is highly popular in business circles as it shows more than meets the eye. There’s no wonder that it is one of the most prominent business valuation methods. 

      2. Market Approach

Marketapproach is based on the competitive principle of valuation which takes into cognizance how much companies of that repute is worth in the general market. It determines the value of a business by the going rate of businesses in that category.


Best business valuation techniques?

Like we identified atthe beginning of this article, it is the purpose for which a business evaluation is carried out that will determine which technique is best.

●     If a business evaluation is carried out to test the impact of a new sales procedure or quality control etc., earnings multiplier technique will be the best method because it focuses on profitinflowas well as revenue.

●     If a business valuation is carried out for a merger situation, it is best to use the asset approach by measuring the value the joining company will bring to the table.

●     If a business valuation is however carried out for an acquisition purpose, of course, anything below market approach would be capitally detrimental.

●     Lastly, if carried out internally by the companyto determine its own worth over time, a market capitalization method (the use of share value) will be sufficient.



So to identify the best method, ask yourself and your team a salient question - “Why are we carrying out this business valuation?”

Written by:
Alex Lopez
Posted on:
July 16, 2018