You need to consider several factors to make the most accurate valuation of your business. The fair price of the business is important for the lender or investor, as well as the valuation of the vehicle, which is important for the insurer. Today there are three main methods of business valuation: income, comparative and cost approach.
Income Approach
It is based on the calculation of the expected income. Income in this method is the decisive factor in the final cost of the enterprise. The more the income, the higher the cost of the business. Multiple factors are taken into account: prospects of the industry, general economic indicators, risks, achievements, and other factors. This method is relevant when buying a perspective business with a view to increasing production. It does not require a deep audit of the company and operates an effective return on assets performance.
This method takes into account the discount rate that allows you to make more accurate predictions on the implied yield and risks in the future. Global investors often use this approach to assess the company’s position in the domestic and global markets.
Comparative Approach
This method is based on a comparative analysis of the main competitors in the market, which produce similar goods. The prerequisite is a similar business environment. The main sources of information are the stock markets.
The advantage of this method is that the value of the company can be estimated from the results of share trades, and the price reflects a specific position in the market at any given time. It includes the method of transactions, capital market, and industry indicators. The indicator of capital shows the position of the company in relation to the direct competitors. With valid data, the valuation of business becomes quite accurate. If the indicators of compared enterprises are different, the multiples (price/earnings, price/cost, etc.) are applied.
Transactions. Using this method, you can trace the results of buying shares of similar businesses in the market. This method is effective in full disclosure of financial and other indicators of economic activity.
Industry indicators. This method takes into account the ratio between the sale price and the business performance of the company.
Cost Approach
This method is based not on the income, but on the costs of organizing a particular kind of business. Thorough reassessment allows to drop ballast. Subtracting all liabilities, you can deduce the exact market value of the company.
The cost approach includes only existing assets that eliminates irrelevant variables. It is effective for the evaluation of young companies, holdings, and investment companies.
The disadvantage is the lack of long term business forecasts. In assessing two different methods are used: the net assets and the liquidation value. Due to the frequent unreliability of the carrying and market values of the company, this method is particularly not in demand.
Each investor and buyer decides what kind of valuation approach to use. Sometimes it is advisable to use several methods to reduce the risk of mistake.