Business valuation methods help you arrive at your company’s value. These methods include various ways of calculating a business’s worth by its income, its market value or its net asset base. They can also be used to sell a business, get a loan, attract investors or plan for future growth. The three main business valuation methods are the income, market, and asset-based approaches. No one option fits all; the different methodologies fit various scenarios and deadline-driven types of businesses.
Business Valuation Approaches
A business valuation method is a standardized methodology for assessing a business’s value, using its income, market value compared to other companies, or the value of its assets.
Let’s discuss these methods in detail. We’ll explore how they work, when to use them, and why they’re suited to different kinds of companies.
Income Approach
The income approach considers the money your company will put in its pocket in the future. It works well when a business is gaining consistently or has good prospects. This enables you to advance future income to today. It is a great help for startups and growing businesses.
How the Income Approach Works?
Here are models that fall under the above categories:
Earnings Capitalization Method
We will use the discounted cash flow (DCF) method to forecast future cash flow. It then discounts those earnings to the present day with a discount rate. This discount rate denotes the risk and the time value of money. Essentially, the higher the risk, the higher the discount rate.
One is the Capitalization of Earnings, which applies a capitalization rate to a single year’s earnings. Symbol: This indicates how secure or risky the company is. You then net out earnings by that to get to the business value.
For example: For instance, if you earn ₹10 lakhs each year from businesses and the rate is 20%, then value = ₹10 lakhs/0.20 = ₹50 lakhs.
Use the income approach if:
- You are a startup or growth-stage company founder
- You will expect steady or increasing profits
- You have expertise in private company valuation.
- You want to show future value.
This method is one of the components of the income approach to valuation, and it is preferred as it uses the forward-looking method. It has also rooted many other business valuation methods. But it needs accurate data. Income guesswork means you end up valuing the business wrong.
This is helpful when the business value of future periods exceeds that of the current one. These are a bunch of the approaches we base upon startup valuation. The last one is also among the company valuation methods when you have a company with high intangible value (such as software, brand, or tech).
Market Approach
The market approach allows you to evaluate the value of your business compared to that of other companies in similar markets. It is identical to checking comparable hardware before you list your own for sale. This is a good approach if comparables are being sold.
How does the Market Approach work?
It has its basis in data, real market data. It looks at how much other people have paid for businesses like yours. Some of the multiples of valuation it uses are:
- Price to Earnings (P/E)
- Price to Sales (P/S)
- EV/EBITDA
You multiply These multiples of earnings or sales in that industry.
For example: If comparable business get sold for 6x their earning and your company earned ₹8 lakhs, your business value = ₹8 lakhs × 6 = ₹48 lakhs
This method consists of two key approaches:
- Guideline Public Company Method (GPCM) – pulls data from publicly traded companies.
- Precedent Transaction Method – Sale prices of private companies
Use the market approach if:
- Your company has established competition
- Everything you need is small business valuation techniques
- You do it at a reasonable price based on ACTUAL deals
This is the most realistic business valuation approach because it reveals what buyers pay. Many experts have used this method in business appraisal, especially in private company valuation.
A company must be recently public; otherwise, it is not good. That approach may not add a specific return unless your company is highly niche-focused.
Asset-Based Approach
With the asset-based method, you are just verifying what you have in your business. It totals all the assets and deducts liabilities. So, this” output” reflects how much your company would be worth as determined by its physical and financial assets.
The Asset-Based Approach in Action
This balance sheet ID is most relevant to companies with many asset bases like factories sho, PS, and property companies. It includes:
- Book Value Method – The book values on your balance sheet
- Adjusted Net Asset Method – This method adjusts asset values to the prevailing market rates
- Formula:
Business Value = Total Assets – Total Liabilities
For example, let’s say you have machines, land, stock, and cash worth ₹60 lakhs. It is ₹20 lakhs for loans and any bills you owe. In this, your business value comes to ₹40 lakhs.
If the asset-based approach would be applied.
- You run an asset-heavy business.
- A straightforward way you want
- Your company is shutting down or sold off for parts
- You can think of it as the foundation value when there are low returns.
It is the foundation of dominant business valuation methods and is among the most common company valuation techniques. This method establishes a useful lower bound during low or extreme profit uncertainty.
From the perspective of service-based businesses or product-based startups with limited assets, this approach would not work at all. It also does not consider the valuation of intangibles that the brand, goodwill or tech may command. So, when people or ideas havel value, both income and market approaches should be applied.
Relevance to ACCA Syllabus
The valuation of the business is one of the key areas of study for the ACCA exams, and you can expect to see it covered under Financial Management (FM) and also heavily featured when it comes to Strategic Business Leader (SBL) and Advanced Financial Management (AFM) subjects as well. M&A is a real part of the business that you can not avoid, and the ACCA students read and understand how companies are valued in mergers, acquisitions, investment decisions, and financial reporting. This knowledge allows practitioners to determine professional judgment in principles such as fair value estimation and investment appraisal, which fall within the scope of IFRS and corporate finance.
Business Valuation Approaches ACCA Questions
Q1: What is the ‘income based approach’ usually followed for valuing a business?
A) Net Asset Value Method
B) Market Capitalization
C) Discounted Cash Flow (DCF)
D) Compare with Similar Companies
Ans: C) Discounted Cash Flow (DCF)
Q2: In business valuations, where does the cost approach primarily come from?
A) Market comparables
B) Book value of assets
C) replacement or reproduction cost of assets
D) Future projected earnings
Ans: C) Cost of assets replacement or reproduction
Q3) For a situation similar to this with relatively similar steady & predictable cash flows, what is the valuation framework that we could deploy to derive fair value of business?
A) Asset-based approach
B) Liquidation value
C) Discounted Cash Flow (DCF)
D) Revenue multiple
Ans:C) Discounted Cash Flow (DCF)
Q4: Valuation of the business with a limited strategy while going ahead for the market approach
A) You are not required to use any financial data
B) It can not value the unmeasurable.
C) IFRS does not accept it
D) Have no Substitute Post Equivalent Instead
Ans: D) Availability of similar firms to compare with
Q5: Which of the following is NOT a typical step when performing a DCF valuation?
A) Cash flow forecast going forward
B) Determining discount rate
C) recent market traded
D) Calculating terminal value
Ans:Correct Answer: C) recent market traded
Relevance to US CMA Syllabus
US CMA includes business valuation in part 2 —Strategic Financial Management of the original curriculum. CMAs require knowledge of a company’s worth before advising on mergers and before any investment or divestiture. CMAs deploy valuation techniques such as discounted cash flow (DCF), net asset value and market comparables, which help back decisions that are consistent with long-term objectives and maximizing shareholder value.
Business Valuation Approaches US CMA Questions
Q1: What is the most common utilization of business valuation for strategic decision making?
A) Prepare audit reports
B) Lower commercial cost
C) Business valuation in respect of a business acquisition or M&As
D) Record daily transactions
Ans: C) For banks, AML/compliance means auditing huge numbers of transactions.
Q2: Income approach of valuation – which metric likely used?
A) PRICE TO EARNINGS MULTIPLE (P/E MULTIPLE)
B) Net income
C) FCFF (Free Cash Flow to Firm)
D) Book value of equity
Ans: (C) FCFF(Free Cash Flow to Firm)
Q3: Why we do DCF valuations based on future free cash flows and never based on amount of future cash?
A) Select a comparable firm
B)Terminal value
C) Forecast free cash flows
D) Cost of capital
Ans: C — Project free cash flows
Q4 : How do you value a start-up company which is bleeding money but is expected to grow exponentially?
A) Net Asset Value
B) Discounted Earnings
C) Market Multiple
D) Revenue Multiple
Ans: D) Revenue Multiple
Q5: What is the valuation approach that is closest to a company WACC?
A) Replacement Cost
B) Market Multiples
C) Discounted Cash Flow
D) Earnings Before Tax
Ans: C) Discounted Cash Flow
Relevance to US CPA Syllabus
Business valuation is predominantly tested on the US CPA exam on the Business Environment and Concepts (BEC) section and on the Financial Accounting and Reporting (FAR) section of the CPA exam. Ask the Experts: Why It’s Important for CPAs to Know Valuation Because for CPAs who are active in fair value measurement and engaged in merger pricing and goodwill testing, valuation is an important skill. Remember that business valuation methods are crucial in developing accurate high-quality financials and other advisory services.
Business Valuation Approaches US CPA Questions
Q1: Is the fair value hierarchy prescribed in GAAP and IFRS a prerequisite for methods of valuation that have to do with meeting the international and the GAAP requirements regarding fair value measurements?
A) Historical Cost Method
B) Replacement Cost
C) Market Approach
D) LIFO Reserve
Ans: C) Market Approach
Q2: What is Terminal value?
A) Final year’s net income
B) The value of cash flows after projection period discounted to the present
C) Company’s tax obligations
D) Aggregate depreciation taken on the asset over its useful life
Ans: B) PV of terminal cash flows
Q3: How can this business be objectively valued based on market data?
A) Market Approach
B) Income Approach
C) Cost Approach
D) Residual Income Method
Ans: A) Market Approach
Q4: In the engagement of a business valuation CPA, the CPA is directed to and employed to you to use an Asset-Based Approach. What is the key input?
A) Projected earnings
B) Market share data
C) Adjusted balance sheet
D) Industry P/E ratio
C) Adjusted balance sheet
Q5: Give an example of type of multiple of the Market Approach?
A) Net Book Value
B) EV/EBITDA
C) Discount Rate
D) Debt-Equity Ratio
Ans: B) EV/EBITDA
Relevance to CFA Syllabus
Business Valuation: This component of the CFA exam would be particularly strong for Levels I–III. It is essential for equity research, portfolio management, and corporate finance. This is something that students in the CFA program do as part of coursework, to learn how these approaches — such as DCF, comparable company analysis, or asset-based valuation — can be relevant with respect to a living, breathing enterprise in order to arrive at a valuation, after which the investment decision can follow.
Business Valuation Approaches CFA Questions
Q1 : Which method in equity valuation relies on the present value of future free cash flows to the firm?
A) Residual Income Model
B) Dividend Discount Model
C) Free Cash Flow Model
D) Asset-Based Valuation
Ans: C) Free Cash Flow Model
Q2: Which valuation method shall be more suitable regarding the firm that has attained the necessary level of maturity and several dividend payments can be forecast?
A) Residual Income Model
B) DCF (discounted cash flow) financial model
C) Net Asset Value
D) Market-to-Book Ratio
Ques: B) Dividend Discount Model DDM
Q3: Among the following, which is NOT a limitation of asset based valuation method?
A) Ignores intangible assets
( b ) at firms whose only activity is production
C) throw it all away
D) Relies on historical costs
Ans: C) Can be applied only in case of winding up
Q4: How to interpret beta in terms of CAPM model for business valuation?
A) Company profitability
B) Interest rate risk
C) Market volatility risk
D) Firm’s equity return
Ans : C) Risk of volatility in the market
Q5: How does the compounding/risk-oriented valuation framework work?
A) Asset-Based
B) Income Approach
C) Book Value Method
D) LIFO Valuation
Ans: B) Income Approach
