Insight
How business valuation methods differ
Two businesses with similar revenue can have very different values. Profitability, future investment, risk, ownership rights and the quality of available evidence all matter. Choosing a method is therefore part of understanding the business, rather than selecting a universal formula.
The International Valuation Standards Council glossary distinguishes income, market and cost approaches. In business valuation, an assessment of adjusted assets and liabilities may also be relevant. The appropriate approach depends on the interest being valued, the purpose and the evidence.
The income approach: future financial benefits
An income approach considers the benefits an owner expects to receive and expresses them as a value today. A discounted cash-flow model considers forecast cash flows over time and the return required for their risk. Its usefulness depends on the quality of the forecasts and assumptions.
A business expecting rapid growth may need substantial investment in equipment, people or working capital. A model that includes the growth but omits the investment would present an incomplete picture. Sensitivity analysis can help show how changes in assumptions affect the conclusion.
Capitalisation of maintainable earnings is another technique used in business valuation. It assesses an earnings level considered sustainable and applies an appropriate capitalisation rate or multiple. Determining sustainable earnings requires judgement about recurring performance and the resources needed to produce it.
The market approach: evidence from comparable businesses
A market approach draws on pricing evidence from comparable businesses or transactions. Relevant comparisons may involve listed companies, completed acquisitions or transactions in the business itself. A revenue or earnings multiple is only informative when the underlying comparison makes sense.
For example, a listed company with diverse customers and established management may differ substantially from a smaller business dependent on one owner. Growth, margins, risk, size and transaction terms need to be considered. An industry average does not remove those differences.
Ask where the evidence comes from, how recent it is and why the selected businesses are comparable. A clear explanation of adjustments is more useful than a multiple presented without its context.
Asset-based assessment: what the business owns and owes
An asset-based assessment considers assets and liabilities, with appropriate adjustments from recorded amounts. It can be relevant where value is closely connected to identifiable assets, such as an investment-holding business. Specialist input may be needed to value particular property or other assets.
The accounting balance sheet is a starting point, not necessarily a valuation. It may omit internally developed intangible assets or contain historical figures that do not reflect current circumstances. A profitable operating business may also have value that cannot be understood by adding up tangible assets alone.
Keep business value and share value distinct
Enterprise value and equity value answer different questions. Broadly, moving from the value of operations to equity value requires consideration of financing and other relevant assets or obligations. The precise treatment depends on the method and assumptions, so cash or debt should not be adjusted twice.
The value of a particular shareholding also requires attention to its rights and restrictions. A percentage of the shares does not, by itself, establish every feature of the interest being valued.
Why methods can produce different answers
Different methods may emphasise different evidence or assumptions. A valuer should investigate those differences and explain the conclusion. Simply averaging unrelated figures can conceal the reason they disagree.
Before comparing two valuations, check the valuation date, subject interest, basis of value and intended use. Also check whether each assessment assumes continuing operations or another premise. The ICAEW valuation guide explains why basis and premise must be established.
A useful report makes its reasoning understandable: the information considered, methods selected, significant assumptions and limits on reliance. Explore business and share valuation services or valuations for an M&A transaction to discuss the question you need answered.
Further reading
- IVSC: valuation terms and approaches.
- IVSC: what IVS asks of a business valuation.
- ICAEW: business and share valuation.
Related reading
- Enterprise value vs equity value: a worked example
- How owner salaries and one-off expenses affect business value
General information only. The appropriate valuation approach and requirements depend on the circumstances, agreed scope and intended use. This article is not a valuation of a particular business or individual legal, tax or financial advice.
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