Business owners frequently find themselves needing to establish a value for their companies. Whether they’re selling an ongoing business, getting divorced, or creating a partnership, it’s vitally important to have an accurate business valuation. However, “value” has different meanings depending on the need, and there are different approaches to determining value.
Three Business Valuation Strategies: Which One is Right for Your Needs?
Each of the three common approaches to determining value has pros and cons, and there are times when one of the strategies will be more important than the others. Most evaluation experts use approaches based on asset value, earning value, and market comparisons. In many cases, all three approaches will be used to get a better overall idea of a company’s worth.
Asset Approach
There are two common asset-based approaches to establishing value. The approach selected will depend on the status of the business. A going concern approach will examine a company’s balance sheet and list all business assets. That includes real estate, equipment, inventory, and accounts payable.
If a company is being closed, a liquidation approach may be the best indicator of value. The liquidation value estimates the net cash remaining after all assets are sold and debts are paid. This valuation approach is commonly used when an owner dies and the business can’t easily be sold.
Earnings Valuation Strategies
This type of valuation is routinely used to estimate how a company will perform in the future. If, for example, a company is cutting edge, it’s future earnings potential may be significant. On the other hand, if the company’s assets and products are aging, the future earning potential may be low.
This approach also depends on the size and nature of the company. A small, service-oriented company may lose value if the current owner is no longer part of the business. Larger companies marketing products are not as likely to suffer if the current owner leaves.
Market Value Approach
In many instances, the prices of sold or currently available competitors’ businesses serve as valuable guides to determining value. For example, a franchise owner that wants to divest may want to base their asking price on what similar businesses in the same area have sold for.
Choosing the Best Valuation Strategy
In most instances, the primary evaluation strategy will be the earnings valuation method, but using only one strategy is not always the best choice. Consider using a combination of evaluation strategies to get a better overall idea of a company’s value.