Explainer: Approaches Used During Business Valuation
Business valuation is a process typically done by a trained analyst that involves determining the true economic value of an enterprise. When an analyst is undertaking a valuation, they can use either of three main valuation methods. It is however worth noting that the best valuation approach to use usually depends on the type of enterprise. The ideal valuation method usually tends to vary since each business usually operates in a unique economic environment and each enterprise usually operates using a unique business model. Below, the focus will be on the top 3 methods used by analysts during business valuation.
1. Asset-Based Valuation Approach
This approach usually considers the total assets owned by an enterprise to determine its present economic value. Under this approach, an analyst usually firsts calculates the value of all assets owned by a company and the liabilities held by the company. The analysts then usually subtracts the value of the liabilities from the value of the assets to find the net value of the business.
2. Earning-Based Valuation Approach
Under this method, an analyst usually looks at the average past earnings of a business and then uses the figures to determine its expected future earnings. On identifying the potential future earnings, the analyst then usually adjusts the figures to reflect what the present value of the enterprise should be.
3. Market Value Approach
Under this method, an analyst usually estimates the current value of a business by looking at what similar enterprises fetched once they were put on the market. This method is rarely used unless there are a lot of similar businesses that have been sold in the recent past. This is because you cannot use the value of one business and compare it to another since every enterprise operating in the market is uniquely different.
It is worth pointing out that though an analyst can use one valuation method, it is usually best to rely on combined valuation approaches to get an accurate and true value of a business.