Although there are objective measures and criteria to follow, valuing a business can be a subjective practice. The outcome relies heavily on the judgment of the appraiser and the assumptions they have deemed appropriate for the company at hand. The final value is also impacted by the approach or combination of approaches that the appraiser believes to be most suitable. These approaches are the asset approach, income approach, and market approach.

Asset Approach

The asset-based approach focuses on determining the value of the business based on its net assets, or its total assets less total liabilities. Initially, the net asset value matches the company's book value, but this may not reflect its fair market value. To get to the fair market value, the appraiser must consider intangible or off-balance sheet assets. In some cases, there are necessary adjustments for the liabilities as well. All assets and liabilities should reflect their current fair market value at the time of the valuation, requiring market research and adjustments such as depreciation for applicable assets.

The asset-based approach is best used for companies that are struggling with liquidity, are very asset-heavy with tight margins, or are looking to liquidate the company. It can also be the preferred method for valuing a company that does not have a normalized income or cash flow, or a company with little to no goodwill or intangibles.

Income Approach

The income approach is a valuation technique that determines the value of a business based on the cash flows generated year to year. This method is performed by forecasting future earnings for the business, calculating a terminal value, and discounting the terminal value back to the present value using an appropriate discount rate. The discount rate reflects both cash flow risk and the time value of money.

It is commonly used in mergers and acquisitions because it is a forward-looking method, and it also captures the risk of achieving forecasted cashflows. This will grab the attention of perspective buyers as they are going to be more interested in the future of the company, not just the historical information.

Market Approach

The market approach is a valuation method based on the transaction price of similar businesses at the time of the valuation. When looking at different transactions, factors such as industry trends, market conditions, and the competitive landscape should be considered. This helps ensure an accurate assessment of the company.

The market approach can be most useful when there is a suitable amount of information on recent sales in the industry available. The more niche the company is, the harder it can be to find relevant and comparable sales. It can also be used to cross-check the other valuation methods to ensure they align with market expectations and provide added support.

Different businesses, situations, and opinions will affect the valuation method used and the outcome of the chosen method. It is important that all assumptions and explanations are clearly stated in the written portion of the final report. The report should also explain why other methods were not the best fit for the business.

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