Business Valuation: Methods and Use Cases

A business valuation estimates how much a business is worth in quantifiable terms. Appraisers conduct business valuations for various purposes, like if the firm plans to sell or make an initial public offering (IPO)—or in the event of business dissolution. While there are several different methods of determining a valuation, these calculations often combine estimations of the worth of intangible assets and factors like the current market and the business’s possible future profitability.

Valuation experts have many tools at their disposal to determine a business’s value. Here are some of the more common valuation methods:

1. 1. Earnings multiplier method: Using a business’s price-to-earnings ratio (or P/E ratio), you can determine value as a function of a business’s profits. The P/E ratio equals the price per share of a company’s stock divided by the earnings per share of that stock.
2. 2. Discounted cash flow method: The DCF method works backward from models of a business’s future cash flow to determine its current value. The discounted cash flow method is useful for determining the value of an investment based on future potential.
3. 3. Liquidation value method: The liquidation value of a company is essentially the net cash you would wind up with if the business paid off all its debts and sold off everything that it could (for example, investments and real estate).
4. 4. Market capitalization method: The market capitalization approach relies on stock ownership. To calculate market capitalization, multiply the share price by the number of shares investors hold to get a rough sense of the present value.
5. 5. Market value method: In this comparative approach, valuators measure a company’s worth against comparable businesses in the same industry to contextualize its relative value.
6. 6. Net worth method: Also known as the book value method, in this approach, appraisers calculating the value of a business rely on financial statements and the balance sheet to subtract a business’s liabilities from its assets.

The valuation method a business uses depends on the purpose of the valuation. If, for example, a company is reporting to the IRS, it will likely want to present a lower valuation for tax purposes. If it’s on the market, a business will probably opt for a model that would result in a higher valuation—and, therefore, a higher asking price.

Generally speaking, a business valuation involves adding up assets and subtracting liabilities or using a relevant multiplier to extrapolate future worth from present conditions. Look for an accountant with an ABV (Accredited in Business Valuation) credential to help determine the best course of action for your business.

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