Valuation involves determining the price of a business.
Valuing a company is an important process for anyone who will be buying, selling or investing in a company. Determining the value of a company is not as straightforward as it might seem, though, as there is no single preferred way to do it. Instead, there are a variety of different methods that can be used to value a firm.
Income Approaches
Income approaches to business valuation focus on the company's cash flows. Income-based approaches include the capital asset pricing model, the weighted average cost of capital and the discount rate method. These different methods consider a firm's income differently, but they all consider this the foundation of the valuation. This type of method is well suited to firms that have strong intangible assets that cannot be easily measured.
Market Approaches
The market approach to valuating businesses considers what the market is willing to pay for a firm. Typically, market approaches will look at similar businesses that have been sold in recent times in order to assess the company's value. For instance, to determine the value of a restaurant, one would look at the value of similarly sized restaurants in the same area of the city or in similar cities in recent months.
Asset Approaches
Asset approaches for valuating businesses are the simplest type of valuation. In essence, asset approaches consider the value of a company's assets. The book value method is a method of valuating a company based simply on its assets and liabilities. A company's liabilities are subtracted from its assets to give the book value. Alternatively, a firm can be valuated using the cost to create method, in which the value is based on the estimated cost to create these assets.
Choosing a Method
Some methods are better suited to certain situations. The income method is preferred in situations where it is difficult to determine the value of a company's assets or where most of the company's assets are intangible. The market approach is suitable when the book value does not accurately portray the value of a company. Asset approaches are good to rely on when the company is being liquidated and has no added value as a complete company. It is often beneficial to use multiple methods to give different perspectives on the value of a company.
