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How to Value a Company: 6 Methods and Examples

• 21 Apr 2017

Determining the fair market value of a company can be a complex task. There are many factors to consider, but it's an important financial skill businesses leaders need to succeed. So, how do finance professionals evaluate assets to identify one number?

Below is an exploration of some common financial terms and methods used to value businesses, and why some companies might be valued highly, despite being relatively small.

What Is Company Valuation?

Company valuation, also known as business valuation, is the process of assessing the total economic value of a business and its assets. During this process, all aspects of a business are evaluated to determine the current worth of an organization or department. The valuation process takes place for a variety of reasons, such as determining sale value and tax reporting.

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How to Valuate a Business

One way to calculate a business’s valuation is to subtract liabilities from assets. However, this simple method doesn’t always provide the full picture of a company’s value. This is why several other methods exist.

Here’s a look at six business valuation methods that provide insight into a company’s financial standing, including book value, discounted cash flow analysis, market capitalization, enterprise value, earnings, and the present value of a growing perpetuity formula.

1. Book Value

One of the most straightforward methods of valuing a company is to calculate its book value using information from its balance sheet . Due to the simplicity of this method, however, it’s notably unreliable.

To calculate book value, start by subtracting the company’s liabilities from its assets to determine owners’ equity. Then exclude any intangible assets. The figure you’re left with represents the value of any tangible assets the company owns.

As Harvard Business School Professor Mihir Desai mentions in the online course Leading with Finance , balance sheet figures can’t be equated with value due to historical cost accounting and the principle of conservatism. Relying on basic accounting metrics doesn't paint an accurate picture of a business’s true value.

2. Discounted Cash Flows

Another method of valuing a company is with discounted cash flows. This technique is highlighted in the Leading with Finance as the gold standard of valuation.

Discounted cash flow analysis is the process of estimating the value of a company or investment based on the money, or cash flows, it’s expected to generate in the future . Discounted cash flow analysis calculates the present value of future cash flows based on the discount rate and time period of analysis.

Discounted Cash Flow =

Terminal Cash Flow / (1 + Cost of Capital) # of Years in the Future

The benefit of discounted cash flow analysis is that it reflects a company’s ability to generate liquid assets. However, the challenge of this type of valuation is that its accuracy relies on the terminal value, which can vary depending on the assumptions you make about future growth and discount rates.

3. Market Capitalization

Market capitalization is one of the simplest measures of a publicly traded company's value. It’s calculated by multiplying the total number of shares by the current share price .

Market Capitalization = Share Price x Total Number of Shares

One of the shortcomings of market capitalization is that it only accounts for the value of equity, while most companies are financed by a combination of debt and equity.

In this case, debt represents investments by banks or bond investors in the future of the company; these liabilities are paid back with interest over time. Equity represents shareholders who own stock in the company and hold a claim to future profits.

Let's take a look at enterprise values—a more accurate measure of company value that takes these differing capital structures into account.

4. Enterprise Value

The enterprise value is calculated by combining a company's debt and equity and then subtracting the amount of cash not used to fund business operations.

Enterprise Value = Debt + Equity - Cash

To illustrate this, let’s take a look at three well-known car manufacturers: Tesla, Ford, and General Motors (GM).

In 2016, Tesla had a market capitalization of $50.5 billion. On top of that, its balance sheet showed liabilities of $17.5 billion. The company also had around $3.5 billion in cash in its accounts, giving Tesla an enterprise value of approximately $64.5 billion.

Ford had a market capitalization of $44.8 billion, outstanding liabilities of $208.7 billion, and a cash balance of $15.9 billion, leaving an enterprise value of approximately $237.6 billion.

Lastly, GM had a market capitalization of $51 billion, balance sheet liabilities of $177.8 billion, and a cash balance of $13 billion, leaving an enterprise value of approximately $215.8 billion.

While Tesla's market capitalization is higher than both Ford and GM, Tesla is also financed more from equity. In fact, 74 percent of Tesla’s assets have been financed with equity, while Ford and GM have capital structures that rely much more on debt. Nearly 18 percent of Ford's assets are financed with equity, and 22.3 percent of GM's.

When examining earnings, financial analysts don't like to look at the raw net income profitability of a company. It’s often manipulated in a lot of ways by the conventions of accounting, and some can even distort the true picture.

To start with, the tax policies of a country seem like a distraction from the actual success of a company. They can vary across countries or time, even if nothing actually changes in the company’s operational capabilities. Second, net income subtracts interest payments to debt holders, which can make organizations look more or less successful based solely on their capital structures. Given these considerations, both are added back to arrive at EBIT (Earnings Before Interest and Taxes), or “ operating earnings .”

In normal accounting, if a company purchases equipment or a building, it doesn't record that transaction all at once. The business instead charges itself an expense called depreciation over time. Amortization is the same thing as depreciation but for things like patents and intellectual property. In both instances, no actual money is spent on the expense.

In some ways, depreciation and amortization can make the earnings of a rapidly growing company look worse than a declining one. Behemoth brands, like Amazon and Tesla, are more susceptible to this distortion since they own several warehouses and factories that depreciate in value over time.

With an understanding of how to arrive at EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for each company, it’s easier to explore ratios.

According to the Capital IQ database , Tesla had an Enterprise Value to EBITDA ratio of 36x. Ford's is 15x, and GM's is 6x. But what do these ratios mean?

6. Present Value of a Growing Perpetuity Formula

One way to think about these ratios is as part of the growing perpetuity equation. A growing perpetuity is a kind of financial instrument that pays out a certain amount of money each year—which also grows annually. Imagine a stipend for retirement that needs to grow every year to match inflation. The growing perpetuity equation enables you to find out today’s value for that sort of financial instrument.

The value of a growing perpetuity is calculated by dividing cash flow by the cost of capital minus the growth rate.

Value of a Growing Perpetuity = Cash Flow / (Cost of Capital - Growth Rate)

So, if someone planning to retire wanted to receive $30,000 annually, forever, with a discount rate of 10 percent and an annual growth rate of two percent to cover expected inflation, they would need $375,000—the present value of that arrangement.

What does this have to do with companies? Imagine the EBITDA of a company as a growing perpetuity paid out every year to the organization’s capital holders. If a company can be thought of as a stream of cash flows that grow annually, and you know the discount rate (which is that company’s cost of capital), you can use this equation to quickly determine the company’s enterprise value.

To do this, you’ll need some algebra to convert your ratios. For example, if you take Tesla with an enterprise to EBITDA ratio of 36x, that means the enterprise value of Tesla is 36 times higher than its EBITDA.

If you look at the growing perpetuity formula and use EBITDA as the cash flow and enterprise value as what you’re trying to solve for in this equation, then you know that whatever you’re dividing EBITDA by is going to give you an answer that is 36 times the numerator.

To find the enterprise value to EBITDA ratio, use this formula: enterprise value equals EBITDA divided by one over ratio. Plug in the enterprise value and EBITDA values to solve for the ratio.

Enterprise Value = EBITDA / (1 / Ratio)

In other words, the denominator needs to be one thirty-sixth, or 2.8 percent. If you repeat this example with Ford, you would find a denominator of one-fifteenth, or 6.7 percent. For GM, it would be one-sixth, or 16.7 percent.

Plugging it back into the original equation, the percentage is equal to the cost of capital. You could then imagine that Tesla might have a cost of capital of 20 percent and a growth rate of 17.2 percent.

The ratio doesn't tell you exactly, but one thing it does highlight is that the market believes Tesla's future growth rate will be close to its cost of capital. Tesla's first quarter sales were 69 percent higher than this time last year.

The Power of Growth

In finance, growth is powerful. It explains why a smaller company like Tesla carries a high enterprise value. The market has taken notice that, while Tesla is much smaller today than Ford or GM in total enterprise value and revenues, that may not always be the case.

If you want to advance your understanding of financial concepts like company valuation, explore our six-week online course Leading with Finance and other finance and accounting courses to discover how you can develop the intuition to make better financial decisions.

This post was updated on April 22, 2022. It was originally published on April 21, 2017.

About the Author

Business Valuation

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on February 26, 2024

Are You Retirement Ready?

Table of contents, what is business valuation.

Business valuation is the process of estimating the economic value of a business or its ownership interest which involves taking into account its financial performance, assets, liabilities, and other relevant factors.

Business valuation is crucial for several reasons, including providing an accurate understanding of a company's value, facilitating informed decision-making, and ensuring transparency in financial transactions like mergers and acquisitions, sales, taxation, and legal disputes.

An accurate business valuation can help business owners and investors make strategic decisions about growth, financing, and exit strategies.

Additionally, business valuation is often required for legal purposes, such as taxation, estate planning, and dispute resolution. In these cases, a thorough and accurate valuation can help ensure compliance with legal requirements and protect the interests of all parties involved.

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[email protected]

I'm Taylor Kovar, a Certified Financial Planner (CFP), specializing in helping business owners with strategic financial planning.

In my early consulting days, I encountered a family-run bakery facing a difficult decision regarding selling their business. Their uncertainty about the value of their business was compounded by emotional attachments. By conducting a thorough cash flow analysis, we were able to identify and highlight less obvious aspects of value, such as their unique recipes and loyal customer base. Adjusting their valuation to take these intangibles into account, they were able to secure a deal that surpassed their expectations.

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Methods of Business Valuation

Asset-based approach.

The asset-based approach to business valuation focuses on determining the value of a company based on the value of its tangible and intangible assets .

This approach involves identifying and valuing the company's assets , then deducting its liabilities to arrive at the net asset value . The asset-based approach is particularly useful for companies with significant assets, as well as for those in financial distress or facing liquidation.

However, this approach has its limitations, as it does not take into account the company's future earnings potential or the value of its intangible assets, which may be significant for some businesses.

Income-Based Approach

The income-based approach to business valuation focuses on estimating the company's value based on its ability to generate future cash flows or profits .

This approach involves projecting the company's future earnings, then discounting those earnings to their present value using a discount rate that reflects the risks associated with the company's operations.

The income-based approach is often used for valuing companies with strong growth prospects or those that derive a significant portion of their value from their ability to generate future cash flows.

However, this approach relies heavily on assumptions about future earnings and can be subject to significant uncertainty and subjectivity.

Market-Based Approach

The market-based approach to business valuation estimates the value of a company by comparing it to similar businesses in the market.

This approach involves analyzing comparable companies or transactions to determine valuation multiples, such as price-to-earnings or price-to-sales ratios , which are then applied to the company being valued.

The market-based approach is useful for valuing companies in well-established industries with a large number of comparable businesses or transactions. However, it may not be suitable for companies in niche markets or industries with limited comparables.

Factors Considered in Business Valuation

Revenue and profitability.

Revenue and profitability are critical factors in determining a company's value, as they reflect the company's ability to generate income and maintain sustainable growth.

A company with consistently strong revenue and profitability is likely to be valued more highly than a company with weaker financial performance.

In business valuation, analysts typically review historical financial statements to assess a company's revenue and profitability trends, as well as to identify any anomalies or patterns that may impact the company's value.

Assets and Liabilities

A company's assets and liabilities play a significant role in its valuation , as they represent the resources available to generate income and the obligations that must be met.

Assets, both tangible and intangible, can contribute to a company's overall value, while liabilities can reduce it.

In the valuation process, analysts review a company's balance sheet to identify and value its assets and liabilities, taking into account factors such as depreciation , market conditions, and potential future growth or decline in asset values.

Cash flow is a critical factor in business valuation, as it represents the company's ability to generate cash from its operations, which can be used to fund growth, pay dividends , or meet debt obligations.

A company with strong, consistent cash flows is generally considered more valuable than a company with volatile or weak cash flows.

Analysts typically examine a company's cash flow statement to assess its cash generation and use patterns, as well as to identify any potential issues or opportunities that may impact its value.

Industry and Market Conditions

Industry and market conditions can have a significant impact on a company's value, as they influence factors such as demand for products or services, competitive dynamics, and regulatory environment.

A company operating in a growing industry with strong market demand may be valued more highly than a company in a stagnant or declining industry.

During the valuation process, analysts consider the company's industry and market conditions, as well as any trends or external factors that may influence its future performance and value.

Management and Employee Quality

The quality of a company's management and employees can also impact its value, as it influences the company's ability to execute its strategies, adapt to changes, and maintain a competitive edge.

Companies with strong, experienced management teams and skilled employees are often valued more highly than those with weaker leadership or workforce capabilities.

In business valuation, analysts may assess the company's management and employee quality through factors such as executive and employee backgrounds, turnover rates, and organizational structure .

Intellectual Property and Patents

Intellectual property (IP) and patents can significantly contribute to a company's value, particularly in industries such as technology, pharmaceuticals, or creative sectors, where innovation and unique assets are critical.

Companies with strong IP portfolios or valuable patents are often valued more highly than those with limited or less valuable IP assets.

During the valuation process, analysts may assess the value of a company's IP and patents by considering factors such as the potential future cash flows generated from those assets, the competitive advantages provided, and the remaining life of the patents.

Types of Business Valuation

Fair market value.

Fair market value is a type of business valuation that estimates the price at which a company would change hands between a willing buyer and a willing seller, with both parties having reasonable knowledge of the relevant facts and neither being under any compulsion to buy or sell.

This is often used in legal contexts, such as taxation and estate planning, as well as for setting transaction prices in business sales or acquisitions .

Investment Value

Investment value is a type of business valuation that estimates the value of a company to a specific investor, taking into account the investor's unique circumstances, objectives, and risk tolerance .

This type of valuation may differ from the fair market value, as it reflects the individual investor's perspective rather than the broader market.

Investment value is often used by investors when evaluating potential investments or determining the value of their existing holdings in a company.

Liquidation Value

Liquidation value is a type of business valuation that estimates the net amount a company would realize if it were to sell its assets and settle its liabilities immediately.

Liquidation value is typically lower than other types of valuation, as it assumes a rapid sale of assets, often at a discount to their fair market value.

This is often used in situations where a company is facing financial distress or bankruptcy and needs to quickly monetize its assets to satisfy its obligations.

Uses of Business Valuation

Sale of business.

Business valuation is essential in the sale of a business, as it provides an objective estimate of the company's worth, which can be used as a basis for negotiating the transaction price.

A thorough and accurate valuation can help business owners ensure they receive a fair price for their company and enable potential buyers to make informed decisions about the investment.

Mergers and Acquisitions

In mergers and acquisitions , business valuation plays a crucial role in determining the value of the target company and assessing the potential benefits and risks of the transaction.

A comprehensive valuation can help acquirers identify synergies, assess the target company's financial health, and determine a fair offer price.

Likewise, for the target company, a thorough valuation can help its owners understand their company's worth and negotiate favorable terms in the transaction.

Taxation and Estate Planning

Business valuation is often required for taxation and estate planning purposes, such as determining the value of a company for tax reporting, gift tax , or inheritance tax purposes.

An accurate valuation ensures compliance with tax regulations and helps business owners and their heirs plan for future tax obligations.

In estate planning , business valuation can also assist business owners in developing succession plans and strategies to preserve and transfer their company's value to future generations.

Litigation and Dispute Resolution

In litigation and dispute resolution, business valuation is often necessary to determine damages, quantify losses, or assess the value of a company in the context of legal disputes, such as shareholder disputes, divorce proceedings, or contractual disputes.

A thorough and accurate business valuation can help parties in a dispute reach a fair resolution and support their legal claims or defenses.

Business Valuation Process

Preparing for valuation.

Before beginning the business valuation process, it is essential to gather all necessary information about the company, including its financial statements , business plan, and other relevant documents.

This information will be used to analyze the company's financial performance , assets, and liabilities, as well as to assess its growth prospects and industry position.

It is also crucial to engage the services of a qualified business valuation professional or firm, who can provide an objective, expert assessment of the company's worth.

Selecting a Valuation Method

Once the necessary information has been gathered, the next step is to select the appropriate valuation method based on the company's characteristics and the purpose of the valuation.

The choice of method will depend on factors such as the company's industry, size, growth prospects, and the availability of comparable transactions or companies.

The selected valuation method should be appropriate for the company's unique circumstances and provide an accurate, objective estimate of its worth.

Collecting and Analyzing Data

After selecting a valuation method, the next step is to collect and analyze the relevant data, such as financial statements, industry reports, and market data.

This analysis will inform the valuation process by providing insights into the company's financial performance, market position, and growth prospects. The data analysis should be thorough and accurate to ensure a reliable valuation.

Applying Discounts and Premiums

In some cases, it may be necessary to apply discounts or premiums to the company's valuation to account for factors such as liquidity , marketability, or control. Discounts and premiums should be applied judiciously, based on objective criteria and supported by empirical evidence.

Finalizing Valuation Report

Once the valuation process is complete, the valuation professional or firm will prepare a comprehensive valuation report that outlines the methodology, data, and assumptions used in the valuation, as well as the final valuation result.

This report should be clear, well-organized, and supported by relevant data and analysis.

The Bottom Line

Business valuation is the process of estimating a company's worth by analyzing its financial performance, assets, liabilities, and other relevant factors. It is essential for various purposes, including sales, mergers and acquisitions, taxation, and legal disputes.

There are several methods of business valuation, including asset-based, income-based, and market-based approaches. Each method has its unique characteristics and is suitable for different situations and types of businesses.

The choice of the valuation method depends on factors such as the company's industry, size, growth prospects, and the availability of comparable transactions or companies.

Various factors are considered in business valuation, including revenue and profitability, assets and liabilities, cash flow, industry and market conditions, management and employee quality, and intellectual property and patents.

Understanding the different valuation methods, factors, and types of valuation can help business owners, investors, and other stakeholders navigate the complex world of business valuation and ensure that they have an accurate, objective assessment of a company's value.

Business Valuation FAQs

What is business valuation.

Business valuation is the process of determining the economic value of a business or company.

What are the methods used in business valuation?

There are three methods used in business valuation: asset-based approach, income-based approach, and market-based approach.

What factors are considered in business valuation?

The financial factors considered in business valuation include revenue and profitability, assets and liabilities, and cash flow. Non-financial factors include industry and market conditions, management and employee quality, and intellectual property.

What are the types of business valuation?

The three types of business valuation are fair market value, investment value, and liquidation value.

What are the uses of business valuation?

Business valuation is used for a variety of purposes, including the sale of a business, merger and acquisition, taxation and estate planning, and litigation and dispute resolution.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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What is Valuation?

Reasons for performing a valuation, 1. buying or selling a business, 2. strategic planning, 3. capital financing, 4. securities investing, company valuation approaches, method 1: dcf analysis.

• Method 2: comparable company analysis (“comps”)

Method 3: precedent transactions

Football field chart (summary), more valuation methods, additional resources, valuation overview.

The process of determining the present value of a company or an asset

Valuation refers to the process of determining the  present value of a company, investment or an asset. There are a number of common valuation techniques, as described below. Analysts who want to place a value on an asset normally look at the prospective future earning potential of that company or asset.

By trading a security on an exchange, sellers and buyers will dictate the market value of that  bond  or stock. However,  intrinsic value is a concept that refers to a security’s perceived value on the basis of future earnings or other attributes that are not related to a security’s market value. Therefore, the work of analysts when performing a valuation is to know if an investment or a company is undervalued or overvalued by the market.

Key Highlights

• Valuation is the process of determining the theoretically correct value of a company, investment, or asset, as opposed to its cost or current market value.
• Common reasons for performing a valuation are for M&A, strategic planning, capital financing, and investing in securities.
• The three most common investment valuation techniques are DCF analysis, comparable company analysis, and precedent transactions.

Valuation is an important exercise since it can help identify mispriced securities or determine what projects a company should invest. Some of the main reasons for performing a valuation are listed below.

Buyers and sellers will normally have a difference in the value of a business. Both parties would benefit from a valuation when making their ultimate decision on whether to buy or sell and at what price.

A company should only invest in projects that increase its net present value . Therefore, any investment decision is essentially a mini-valuation based on the likelihood of future profitability and value creation.

An objective valuation may be useful when negotiating with banks or any other potential investors for funding. Documentation of a company’s worth, and its ability to generate cash flow, enhances credibility to lenders and equity investors.

Investing in a security, such as a stock or a bond, is essentially a bet that the current market price of the security is not reflective of its intrinsic value . A valuation is necessary in determining that intrinsic value.

When valuing a company as a going concern, there are three main valuation techniques used by industry practitioners: (1) DCF analysis , (2) comparable company analysis, and (3) precedent transactions. These are the most common methods of valuation used in  investment banking , equity research, private equity, corporate development, mergers & acquisitions ( M&A ), leveraged buyouts ( LBO ), and most areas of finance.

As shown in the diagram above, when valuing a business or asset, there are three different approaches one can use. The asset approach calculates the fair market value of individual assets, often including the cost to build or cost to replace. The asset approach method is useful in valuing real estate, such as commercial property, new construction, or special-use properties. 

Next is the income approach, with the discounted cash flow (DCF) being the most common. A DCF is the most detailed and thorough approach to valuation modeling. 

The final approach is the market approach, which is a form of relative valuation and is frequently used in the finance industry. It includes comparable company analysis and precedent transactions analysis.

Discounted cash flow (DCF)  analysis is an  intrinsic value  approach where an analyst forecasts a business’s unlevered  free cash flow into the future and discounts it back to today at the firm’s weighted average cost of capital ( WACC ).

A DCF analysis is performed by  building a financial model  in Excel and requires an extensive amount of detail and analysis. It is the most detailed of the three approaches and requires the most estimates and assumptions. Therefore, the effort required to preparing a DCF model may also often result in the least accurate valuation due to the sheer number of inputs. However, a DCF model allows the analyst to forecast value based on different scenarios and even perform a sensitivity analysis.

For larger businesses, the DCF value is commonly a sum-of-the-parts analysis, where different business units are modeled individually and added together.

Method 2: comparable company analysis (“comps”)

Comparable company analysis  (also called “trading comps”) is a relative valuation method  in which you compare the current value of a business to other similar businesses by looking at trading multiples like P/E,  EV/EBITDA , or other multiples. 

The “comps” valuation method provides an observable value for the business, based on what other comparable companies are currently worth. Comps is the most widely used approach, as the multiples are easy to calculate and always current. The logic follows that if company X trades at a 10-times P/E ratio, and company Y has earnings of $2.50 per share, company Y’s stock must be worth $25.00 per share (assuming the companies have similar risk and return characteristics).

Precedent transactions analysis  is another form of relative valuation where you compare the company in question to other businesses that have recently been sold or acquired in the same industry. These transaction values include the take-over premium included in the price for which they were acquired.

The values represent the entire value of a business and not just a small stake. They are useful for M&A transactions but can easily become dated and no longer reflective of current market conditions as time passes.

Investment bankers will often put together a  football field chart  to summarize the range of values for a business based on the different valuation methods used. Below is an example of a football field graph, which is typically included in an  investment banking pitch book .

As you can see, the graph summarizes the company’s 52-week trading range (it’s stock price, assuming it’s public), the range of prices equity research analysts have for the stock, the range of values from comparable valuation modeling, the range from precedent transaction analysis, and finally the DCF valuation method. The orange dotted line in the middle represents the average valuation from all the methods.

Another valuation method for a company that is a going concern is called the  ability-to-pay analysis . This approach looks at the maximum price an acquirer can pay for a business while still hitting some target. For example, if a private equity  firm needs to hit a  hurdle rate  of 30%, what is the maximum price it can pay for the business?

If the company does not continue to operate, then a  liquidation value  will be estimated based on breaking up and selling the company’s assets. This value is usually very discounted as it assumes the assets will be sold as quickly as possible to any buyer.

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What Is Valuation?

Understanding valuation, how earnings affect valuation, limitations of valuation.

• Valuation FAQs

The Bottom Line

• Corporate Finance
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What Is Valuation? How It Works and Methods Used

James Chen, CMT is an expert trader, investment adviser, and global market strategist.

• Valuing a Company: Business Valuation Defined With 6 Methods
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• Fundamental Analysis
• Absolute Value
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• Intrinsic Value vs. Current Market Value
• Equity Valuation: The Comparables Approach
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• Decoding DuPont Analysis
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Valuation is the analytical process of determining the current or projected worth of an asset or company. Many techniques are used for doing a valuation. Among other metrics, an analyst placing a value on a company looks at the business's management, the composition of its capital structure , the prospect of future earnings, and the  market value of its assets.

Fundamental analysis is often employed in valuation although several other methods may be employed such as the capital asset pricing model (CAPM) or the dividend discount model (DDM).

Key Takeaways

• Valuation is a quantitative process of determining the fair value of an asset, investment, or firm.
• A company can generally be valued on its own on an absolute basis or a relative basis compared to other similar companies or assets.
• Several methods and techniques can be used to arrive at a valuation, each of which may produce a different value.
• Valuations can be quickly impacted by corporate earnings or economic events that force analysts to retool their valuation models.
• Valuation is quantitative in nature but it often involves some degree of subjective input or assumptions.

Investopedia / Mira Norian

A valuation can be useful when you're trying to determine the  fair value of a security determined by what a buyer is willing to pay a seller assuming that both parties enter the transaction willingly. Buyers and sellers determine the market value of a stock or bond when a security trades on an exchange.

The concept of intrinsic value refers to the perceived value of a security based on future earnings or some other company attribute. It's unrelated to the market price of a security and this is where valuation comes into play. Analysts do a valuation to determine whether a company or asset is overvalued or undervalued by the market.

Types of Valuation Models

• Absolute valuation models  attempt to find the intrinsic or "true" value of an investment based only on fundamentals. You would focus only on things such as dividends, cash flow, and the growth rate for a single company. You wouldn't worry about any other companies. Valuation models that fall into this category include the dividend discount model, discounted cash flow model, residual income model, and asset-based model.
• Relative valuation  models operate by comparing the company in question to other similar companies. These methods involve calculating multiples and ratios such as the price-to-earnings multiple and comparing them to the multiples of similar companies.

The original company might be considered undervalued if the P/E is lower than the P/E multiple of a comparable company. The relative valuation model is typically a lot easier and quicker to calculate than the absolute  valuation  model. This is why many investors and analysts begin their analysis with this model.

Types of Valuation Methods

You can do a valuation in various ways.

Comparables Method

The comparable company analysis  looks at companies that are in size and industry and how they trade to determine a fair value for a company or asset. The past transaction method looks at past transactions of similar companies to determine an appropriate value. There's also the asset-based valuation method which adds up all the company's asset values to get the intrinsic value assuming that they were sold at fair market value.

A comparables approach is often synonymous with relative valuation in investments.

Sometimes doing all these and then weighing each is appropriate to calculate intrinsic value but some methods are more appropriate for certain industries. You wouldn't use an asset-based valuation approach to valuing a consulting company that has few assets. An earnings-based approach like the DCF would be more appropriate.

Discounted Cash Flow Method

Analysts also place a value on an asset or investment using the cash inflows and outflows generated by the asset. This is called a discounted cash flow  (DCF) analysis. These cash flows are discounted into a current value using a discount rate which is an assumption about interest rates or a minimum rate of return assumed by the investor.

DCF approaches to valuation are used in pricing stocks such as with dividend discount models like the Gordon growth model.

The firm analyzes the cash outflow for the purchase and the additional cash inflows generated by the new asset if a company is buying a piece of machinery. All the cash flows are discounted to a present value and the business determines the net present value (NPV). The company should invest and buy the asset if the NPV is a positive number.

Precedent Transactions Method

The precedent transaction method compares the company being valued to other similar companies that have recently been sold. The comparison works best if the companies are in the same industry. The precedent transaction method is often employed in mergers and acquisition transactions.

The earnings per share  (EPS) formula is stated as earnings available to common shareholders divided by the number of common stock shares outstanding. EPS is an indicator of company profit because the more earnings a company can generate per share the more valuable each share is to investors.

Analysts also use the price-to-earnings (P/E) ratio for stock valuation. This is calculated as the market price per share divided by EPS. The P/E ratio calculates how expensive a stock price is relative to the earnings produced per share.

An analyst would compare the P/E ratio with other companies in the same industry and with the ratio for the broader market if the P/E ratio of a stock is 20 times earnings. Using ratios like the P/E to value a company is referred to as a multiples-based or multiples approach valuation in equity analysis. Other multiples such as EV/EBITDA are compared with similar companies and historical multiples to calculate intrinsic value.

It's easy to become overwhelmed by the number of valuation techniques available to investors when you're deciding which valuation method to use to value a stock for the first time. Some valuation methods are fairly straightforward. Others are more involved and complicated.

Unfortunately, no one method is best suited for every situation. Each stock is different and each industry or sector has unique characteristics that can require multiple valuation methods. Different valuation methods will produce different values for the same underlying asset or company which can lead analysts to employ the technique that provides the most favorable output.

What Is an Example of Valuation?

A common example of valuation is a company's market capitalization. This takes the share price of a company and multiplies it by the total shares outstanding. A company's market capitalization would be $20 million if its share price is $10 and the company has two million shares outstanding.

How Do You Calculate Valuation?

You can calculate valuation in many ways. They'll differ based on what's being valued and when. A common calculation in valuing a business involves determining the fair value of all of its assets minus all of its liabilities. This is an asset-based calculation.

What Is the Purpose of Valuation?

The purpose of valuation is to determine the worth of an asset or company and compare that to the current market price. This is done for a variety of reasons such as bringing on investors, selling the company, purchasing the company, selling off assets or portions of the business, the exit of a partner, or inheritance purposes.

Valuation is the process of determining the worth of an asset or company . It's important because it provides prospective buyers with an idea of how much they should pay for an asset or company and how much prospective sellers should sell for.

Valuation plays an important role in the M&A industry as well as the growth of a company. There are many valuation methods, all of which come with their pros and cons.

UNDER30CEO. " Absolute Valuation Formula ."

CFI Education. " Relative Valuation Models ."

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Mon, Jun 5, 2017

Business Valuation - The Basics

Paul Barnes

A business valuation  requires a working knowledge of a variety of factors, and professional judgment and experience. This includes recognizing the purpose of the valuation, the value drivers impacting the subject company, and an understanding of industry, competitive and economic factors, as well as the selection and application of the appropriate valuation approach(es) and method(s). Some of the more important considerations are discussed below.

What is the purpose of the valuation? Identifying the purpose of the business valuation is a critical first step in the process as it dictates the “basis of value” or “standard of value” to be applied, which, in turn, impacts the selection of approaches, inputs and assumptions considered in the valuation. The purpose of a valuation could be for acquisition or sale, litigation, taxation , insolvency , or financial reporting , to name just a few. Once the purpose is identified, the appropriate standard of value can be applied. For example, a tax valuation for U.S. tax reporting generally requires fair market value, defined by U.S. tax regulations and further interpreted by case law while financial reporting requires fair value as defined by U.S. and IFRS accounting standards as a basis of value. While all valuations, regardless of purpose, share certain common attributes, there are differences that need to be reflected in the analysis pursuant to the basis of value. These differences can have a significant impact on the outcome of the business valuation.

What basis of value should apply? The basis of value (or simply put, value to whom?) describes the type of value being measured and considers the perspectives of the parties to the assumed transaction. For example, the basis of value may be defined as the value between a willing buyer and a willing seller or as the investment value to the current owner. Thus, the basis of value may have a significant impact on the selection of valuation approach(es), method(s), inputs and assumptions. It is often specified by a statute, regulation, standard, contract or other document, pursuant to which the valuation is performed. Therefore, the purpose of the valuation and the applicable basis of value are linked.

What premise of value should be used? The valuation approach(es), inputs and assumptions applied are highly dependent on the selected premise of value. The premise of value is driven by the purpose of the valuation and basis of value used, and generally falls into the following categories:

• A going concern premise is the most common premise of value; it presumes the continued use of the assets, and that the company would continue to operate as a business.
• An orderly or forced liquidation premise incorporates an in-exchange assumption (i.e., the assets are operated or sold individually or as a group, not as part of the existing business).

What is the subject of the valuation? The subject of the valuation is of vital importance to the valuation process, the selection of inputs and approach(es) and method(s). Valuing the invested capital or common equity of a business, options, hybrid securities, or some other form of financial interests in a business each require the application of specific valuation methods (a.k.a. techniques, all falling under three main valuation approaches), that are tailored to reflect their specific attributes and terms. Additional complexities arise when one valuation may be required as an input to perform another. For instance, a business valuation may serve as an input or a distinct step in the valuation of stock options, preferred stock, or debt. A business interest (ownership interest in a business), on the other hand, may be characterized by various rights and preferences such as voting rights, liquidation preferences, redemption provisions, and restrictions on transfer, each having an impact on the value measurement.

How has the business performed historically? Regardless of the business valuation approach applied, an understanding of the company’s history and evolution, management and ownership structure, and financial measures of historical performance, is imperative. Financial ratio, margin and growth analysis - the nature of which may vary across industry sectors - provide requisite insight into historical performance. Industry benchmarks offer a frame of reference to evaluate the subject company’s performance relative to its peer group. For example:

• The ratio of enterprise value to the historic amount of invested capital provides an indication of the market’s perception of the ability of the guideline companies to create value. 
• Measures such as return on invested capital (ROIC) and an evaluation of competitive advantages, including unique or innovative products, offer insight into how value is being created in the industry, and present benchmarks to assess the performance of the subject company.

Analyses of historical performance also require careful consideration of additional items and factors, such as non-operating assets and non-recurring events. Businesses are generally valued by first estimating the value of the operations and then adding any non-operating assets. Therefore, isolating and valuing the non-operating assets is important, especially when they are material. Non-recurring events should be removed from historical performance in order to get a more representative measure of the indicated future value of operations.

What is the future outlook for the business? While the historical analyses described above are a key consideration, so are a company’s future prospects. After all, a business derives its value primarily through its ability to create value in the future. In simple terms, value is created when management invests available capital in a manner that provides returns in excess of the cost of that capital. When investment returns equal the cost of capital, no value is created, and when returns fall below the cost of capital, value is eroded.

An assessment of a company’s future outlook comprises understanding the company’s continued strategy in managing its current operations and the expected performance of its future investments. This may include the evaluation of detailed forecasts, revenue, volume and market share data, operating expenses, taxes, capital requirements, cost of capital, etc., and various scenarios thereof. Industry and guideline company analyses also provide insight into a company’s expected performance and future value creation, on a more macro level.

Understanding management’s expectations for the ongoing value creation process; whether it would be built upon continuing successes of the past or through new strategic directions; and whether it is to be generated organically or through acquisitions, is critical in evaluating the future outlook of the business. Business expectations that deviate significantly from prior performance should trigger an incremental level of scrutiny in the analysis due to the lack of historical reference points.

Which valuation approaches should be utilized? With all this foundational information and the assumptions in place, the analysis turns to the selection of valuation approach(es). The income, market and cost approaches are the three generally accepted valuation approaches. The selection of valuation approach(es) depends on the facts and circumstances of the subject company. A brief summary of each approach follows.

Income Approach: The income approach converts future cash flows into a single present (discounted) amount, while reflecting current expectations about such future cash flows.

The discounted cash flow (“DCF”) is the most recognized method under the income approach. In very broad terms, the DCF method captures the operating value of a business in two primary components: (1) the present value of projected cash flows over the discrete projection period, and (2) the present value of the cash flows beyond the discrete projection period, reflected in a residual (terminal, or continuing) value calculation. A DCF may be applied to estimate enterprise value through the present value of cash flows available to all investors (e.g. debt-free cash flows), or to directly measure the value of equity by discounting equity-level cash flows.

A number of additional issues come into play when applying the DCF method, including understanding the underlying nature of the cash flow projections (e.g. a single most likely case vs. a weighted average of various scenarios, or expected cash flows); assessment of the continuing value beyond the discrete projection horizon; and selection of a discount rate (cost of capital) consistent with the nature and risk of the projections.

In addition to the DCF method, there are other methods or techniques categorized as methods under the income approach such as Monte Carlo simulation, contingent claims analysis, discounted economic profit, and real options analysis, which are applied when appropriate.

Market Approach: The market approach uses prices and other relevant information generated by market transactions involving identical or comparable (similar) companies or assets to benchmark the value of the subject business or business interest.

Two market approach methods commonly utilized in a business valuation are the Guideline Company method and the Guideline Transaction method, both of which provide indications of the value of a business by applying various ratios of value (e.g., enterprise value, equity value, price per share) to financial metrics (e.g. earnings before interest expense, depreciation and amortization “EBITDA”, after-tax earnings, revenue) or nonfinancial parameters (e.g. number of subscribers) derived from publicly traded companies or market transactions.

Comparability between the subject company and the guideline companies or transactions is paramount when applying the market approach, as is the selection of the appropriate type of multiple(s), the selection of the appropriate range of observed multiples, and the manner in which they are applied to the subject company. Furthermore, a valuation would consider potential adjustments to the multiples, including adjustments for non-operating assets, unfunded pension liabilities, and operating leases, as well as growth (e.g. price/earnings growth ratios, or PEG). Identifying guideline companies or transactions, adjusting the financial statements of the peer group, and deriving relevant multiples requires an understanding of the history and outlook of both the guideline companies and the subject company.

Additionally, analyzing prior transactions or offers for shares of the subject company, if any, is another form of the application of the market approach.

Cost Approach: The cost approach reflects the amount that would be required currently to replace the service capacity of an asset.

Thus, many associate the cost approach with the replacement cost method which is more appropriate to apply to an individual asset rather than a business. However, a cost approach may be of use for early stage or start-up companies where comparisons to guideline companies are unreliable, or projections are so subjective that they cannot be reliably estimated. Also, entrepreneurs often think of the value of their business in terms of the investment that would be required to replace the assets they have assembled.

The adjusted net assets method (also known by other names) can also be applied to value a business under certain circumstances. This method derives the value of the overall business by estimating the value of the underlying assets and liabilities comprising the business (tangible and intangible assets, whether recorded on the balance sheet or not), whereby each of the component assets and liabilities would be valued under the cost, market or income approach(es), as appropriate.

In a valuation analysis, the valuation approach(es) and method(s) most appropriate in the circumstances would be applied, considering the availability of relevant data.

How do you arrive at a conclusion of value? The resulting value indications from the approaches and methods applied would be evaluated and weighted, on a qualitative basis, as appropriate. In many cases, a greater weight may be ascribed to a particular approach. For example, when the guideline companies are not truly comparable to the subject company, a greater weight may likely be placed on the indication of the income approach. However, this should not preclude consideration of the market approach altogether, as it can still serve as a reasonableness check of the valuation conclusion.

If the valuation is for a business interest (for example, a minority, or non-controlling ownership interest in the business), additional adjustments for lack of control and/or lack of liquidity or restrictions on marketability may be required, depending on the facts and circumstances, and the specific rights of the holders of the class of equity interest.

As you can see, the valuation of a business or a business interest is often a complex process involving a number of considerations, ranging from defining the purpose of the valuation, the basis and premise of value used, the historical performance and future outlook for the subject of the valuation. While standard valuation approaches exist, the challenges lie in selecting the appropriate approach(es), developing the inputs, appropriately weighting the value conclusions, and making any adjustments, using judgement. While valuation appears to be entirely quantitative, the reality is that significant consideration is also given to all relevant qualitative factors, and that professional judgment is critical.

Duff & Phelps is a recognized thought leader on calculating cost of capital, and publishes a number of books and related materials on the topic.

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9 Business Valuation Methods: What's Your Company's Value?

Table of contents

This post was originally published in April 2022 and has been updated for relevancy on May 7, 2024.

Whether you’re on the buy-side or sell-side , having an accurate valuation of your business is an essential part of extracting value from a transaction. Those that are better able to value assets are the most successful investors of all time. And while you can add value to a transaction through a successful integration , paying the right price for a company gives you the best platform to do so.

What is Business Valuation?

Company Valuation or Business Valuation, is the process by which the economic value of a business, whether a large or small business is calculated. The purpose of knowing the business’s value is to find the intrinsic value of the entire company - its value from an objective perspective. Valuations are mostly used by investors, business owners, and intermediaries such as investment bankers, who are seeking to accurately value the company’s equity for some form of investment.

Although business valuations are mostly used to value a company’s equity for some form of investment, it isn’t the only reason to have an understanding of a company’s value. A company is not unlike most other long-term assets, in that it’s useful to have a handle on how much it is worth. Being in an informed position at all times enables the company’s owners to understand what their options are, how to react in different business situations, and how their company’s valuation fits into the bigger picture.

The objectives for valuing a business can be divided into: internal motives, external motives, and mixed motives (being a combination of internal and external motives).

The Business Valuation Process

Every business valuation process differs based on which method you choose to evaluate.

Whatever method you use, the final aim is to find the company’s intrinsic value.

Depending on the company, whether private or public, entrepreneurs or individuals conducting the business valuation process, the method can differ. For example, should a company be measured based on its assets, its future free cash flows, recent transactions for comparable companies, or the sum of its real options? More often than not, valuation professionals seek to use a combination of these to arrive at an answer.

The valuation methods they use are summarized in the table below

More often than not, business valuation professionals use at least two methods when valuing companies, the most common being the DCF method and comparable transactions. These methods are popular because they’re widely understood, but also because the underlying numbers are easier to obtain. In the case of real options valuation, for example, the numbers which underpin the value of the business are far more difficult to objectively ascertain.

Business Valuation Methods

• Discounted Cash Flow Analysis
• Capitalization of Earnings Method
• EBITDA Multiple
• Revenue Multiple
• Precedent Transactions
• Liquidation Value / Book Value
• Real Option Analysis
• Enterprise Value
• Present Value of a Growing Perpetuity

1. Discounted Cash Flow Analysis

Discounted cash flow analysis uses the inflation-adjusted future cash flows to project a value for the business. The thinking behind DCF Analysis is that free cash flows are what endow shareholders with value and only that number that matters.

The problem then arises of how to accurately project discounted free cash flows (FCF), using a weighted average cost of capital (WACC) several years into the future. Even small differences in the metrics, growth rate, the perpetual growth rate and the cost of capital can lead to significant differences in valuation, fueling criticism of the method.

DCF = CF 1 / (1+r) 1 + CF 2 / (1+r) 2 + ....+ CF n / (1+r) n​

Where, CF 1 = The cash flow for year one, CF 2 = The cash flow for year two, n = Number of years, r = Discount rate

For example, let's consider a company with projected FCF of $1 million for the next 5 years. Assuming a discount rate of 10%, the company's future cash flows amount to approximately $3.79 million.

2. Capitalization of Earnings Method

The capitalization of earnings method is a neat, back-of-the-envelope method for calculating the value of a business, which in fact is used by DCF Analysis to calculate the perpetual earnings (i.e. all those earrings that occur after the terminal year of the DCF Analysis being performed).

Sometimes called the Gordon Growth Model, this method requires that the business have a steady level of growth and cost of capital.The numerator, usually the free cash flow, is then divided by the difference between the discount rate and the growth rate, expressed as fractions to arrive at an approximation of a valuation.

Market Capitalization = CF 1 / (r-g)

Where, CF 1 = Cash flow in the terminal year, r =  Discount rate , g = Growth rate

For example, consider a company with projected FCF of $1 million in the terminal year, a discount rate of 10%, and a growth rate of 5%. Using the capitalization of earnings method, the value of the company would be approximately $20 million.

3. EBITDA Multiple

The EBITDA multiplier is an excellent solution to the arbitrary nature of most valuation methods. Even Aswath Damodaran, the father of modern valuation, says that any valuation of a business should follow the law of parsimony: the most simple of two (or more) competing theories should hold sway in an argument.

On this basis, the EBITDA multiple - the multiplication of this year’s EBITDA figure by a multiplier agreeable to both the buyer and seller - is an elegant solution to the valuation dilemma.

Even those who consider this method too simplistic tend to use it as a guide for their valuations, underlining its strength.

4. Revenue Multiple

This method can be used in those circumstances where EBITDA is either negative or isn’t available for some reason (usually because sales figures are the only ones available when researching firms to acquire through online search).

Again, while you might say it’s just a benchmark - others would argue, with some justification, that the total sales of a business is the most important benchmark of all.

5. Precedent Transactions

This method may incorporate the EBITA and revenue multipliers or any other multiple that the practitioner wishes to use. As the title suggests, here the valuation is derived from comparable transactions in the industry.

So, for example, if widget makers have been trading at multiples of somewhere between 5 and 6 times EBITDA (or net income, or whatever indicator is chosen), Widget Co. would establish its value by performing the same iterative process.

The problem that then arises, is how similar are companies to others, even in their own industry?

Thus, for our money, this is more of a barometer of the market than a valuation method per se.

6. Book Value/Liquidation Value

The liquidation value is what Warren Buffett claims to have always looked at when seeing if businesses are overvalued on the stock market or not.This value is the net cash that a business would generate if all of its liabilities were paid off and its assets were liquidated today.

In a sense, calling this a valuation method for a business is a misnomer - this only gives you the value of part of the business.

But, to paraphrase Buffett, it allows you to see the ‘margin of error’ that you have with a valuation.

The logic goes that, even if everything goes wrong in management and the company’s sales fall dramatically after the acquisition, it can always fall back on the liquidation value.

7. Real Option Analysis

Proponents of real options analysis look at businesses as nothing more than a nexus of real options: the option to invest in opportunities, the option to utilize spare capacity, the option to hire more salespeople, etc.

Bringing together these options is the basis behind real options analysis for valuation.

This is most effective for firms with uncertain futures, usually those who aren’t yet cash generative: startups and mineral exploration firms, for example.

Of the valuation methods on this list, it’s by some distance the most complicated but its proponents include McKinsey and several of the world’s most prestigious business schools.

8. Enterprise Value

Enterprise Value (EV) is a method to measure the company’s total market value where we not only consider the company's equity but also its debt obligations and cash reserves.By including debt, we can provide a more accurate picture of a company’s value, especially in the context of mergers or acquisitions, as it represents the total cost to acquire the company’s operations.  

EV = Market Capitalization + Total Debt - Cash and Cash Equivalents 

For example, if a company has a market capitalization of $50 million, total debt of $20 million, and cash reserves of $5 million, its enterprise value would be $65 million ($50M + $20M - $5M).

9. Present Value of a Growing Perpetuity

The Present Value (PV) of a Growing Perpetuity is a valuation method which is used to estimate the total value of cash flows that continue indefinitely and grow at a constant rate. It's often applied in situations where cash flows are expected to continue indefinitely, such as in perpetuity. We can calculate the present value of a growing perpetuity with:

PV = C / (r-g)

Where, C = Cash flow at the end of the first period. r =  Discount rate, g = Growth rate

For example, if a company generates a cash flow of $1 million at the end of the first period, and the discount rate is 8%, with a growth rate of 3%. Then the present value of the growing perpetuity would be $20 million.

How to Pick the Right Valuation Method?

The previous section discussed how most business valuation professionals use at least two methods of valuation, and also that the valuation (the output) will ultimately only be as good as the numbers used to achieve it (the inputs).

After conducting a preliminary analysis of the company, whoever is conducting the valuation chooses the method, which is most suitable to the business and its industry.

There is no question that the biggest determinant of the valuation method used is available information. To take the example of comparable transactions, without any reasonably comparable transactions, there is no way that this valuation method can be conducted.

Here is an example of intangible assets valuation.

Even transactions in the same space from several years before cannot be considered accurate representations of a company’s value in the current environment.

In a similar vein, even the most commonly used valuation method, the DCF method, requires users to forecast free cash flows to a predetermined point in the future. Only in the most extreme cases - for example, a company with a remarkably small number of clients and pre-agreed contracts - is this feasible.

But information is just one of the factors which should determine which is the right valuation method to choose. The others are as follows:

Type of the company

If a company is asset-light, such as is the case with many service companies, it makes little sense to use the net-asset valuation method. Similarly, if most of a company’s value is in its branding or IP, it may make little sense to use the discounted cash flow method.

Size of the company

Larger companies tend to be applicable for a larger number of valuation methods. Small companies, with less information, are usually only subject to a handful of valuation methods. Bear in mind too that different valuation considerations are at play for each (e.g., higher valuation multiples for larger companies).

Economic environment

Regardless of which method is chosen, it’s never a bad idea to consider the economic environment that the company faces. But in more positive economic conditions, it’s important to be somewhat conservative when valuing in the understanding that all business cycles come to an end.

A further consideration for valuing a company is what the end user requires the valuation for. Some buyers will only look at the value of a company’s fixed asset value, be that technology, real estate, or even trucking. Others will only be interested in cash-flow generating potential (as is the case with most buyers of SAAS platforms).

How to carry out a successful valuation of a company

There are a few ways in which a valuation professional can ensure that, whatever the valuation method they choose, they’ll arrive at a number which approximates intrinsic value.

Successful valuation factors are:

A valuation which is heavily influenced by an opinion can be regarded as just that - an opinion.

The valuation should consider as much as possible; not just a company’s assets or its cash flows, but also its environment, and other internal and external factors.

Holistic does not mean detail for the sake of detail. Valuing Amazon doesn’t require making projections about the future prices of cardboard packaging.

Justifiable

Anyone reading the valuation should be able to arrive at the same conclusion as the individual conducting the valuation based on the information provided.

Business valuation providers

Business valuation is the bread and butter of investment banks and M&A intermediaries.

Even if a company has the wherewithal to conduct their own business valuation, it pays to hire a third party specialist for the expertise that they bring to the task. Even legal firms now typically have an in-house valuations expert.

Depending on the valuation method(s) used by the business valuation providers, the company can change the inputs over time to see how their valuation evolves.Accredited business valuation providers can also  ensure reliable and accurate valuations. These specialists adhere to industry standards and bring valuable insights to the table, enabling companies to make informed decisions regarding their valuation strategies.

Closing Remarks

The minute-by-minute fluctuation of the stock prices reflect the reality that there can never be a true consensus on a company’s valuation: everybody has their own.

Blue chip Investment banks, keen to let everybody know that they’re hiring the best quantitative analysts in the world, can also vary widely on price. The upcoming IPO of British chip manufacturer ARM is a case in point. The value of the IPO pitched by investment banks has ranged from $30 billion to $70 billion - a massive $40 billion difference. Most of these bankers will be wrong by billions of dollars, illustrating the difficulty of business valuations.

What links all of the methods mentioned here is that their users have, at one time or another, plugged numbers into a model which gave a number they thought was erroneous, only to replace the numbers moments later to arrive at a number they considered ‘more reasonable’. The best advice is to use as many measures as possible to arrive at a valuation. The more insights you can garner on its revenues, EBITDA, free cash flows, assets and real options, the better a perspective you gain of the company’s true value.

The DealRoom M&A Optimization Platform optimizes the M&A process to increase efficiency and accelerate synergy realization.Whether you need an advanced M&A pipeline tool to enable pipeline management or an end-to-end M&A platform to manage your complete lifecycle, DealRoom has the solution for you.

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What is a Business Valuation?

What is a business valuation?  

When talking about a business valuation, the first step is to clearly define the term itself. Simply put, a business valuation is “The act or process of determining the value of a business enterprise and the ownership interest therein.”

But as important as understanding the definition is, understanding the purpose – or goal – for performing a valuation is equally as critical. There are a wide range of personal and corporate situations that necessitate a valuation.  From individuals to entrepreneurial start-ups to well established Fortune 100 companies, valuations are a key financial tool. Insurance planning, estate planning and financial reporting can rely on a valuation.  A variety of business documents are also dependent on valuations, including buy-sell agreements, shareholder agreements, and sales agreements. In fact, circumstances that typically use the detailed data provided by a valuation include strategic planning, succession planning, restructuring or conducting a merger or acquisition.  It is clear that over time, business leaders, management teams and individuals are at some point likely to find themselves requiring a valuation.

The process is integral under so many conditions – and as such, so many essential decisions are based on the results. Therefore, it is crucial to understand exactly how value is accurately determined.

Value is determined by purpose

There are many reasons for performing a valuation. The driving factor could be financing, estate planning/settlement, gifting, M&A, shareholder litigation, divorce, impairment testing, or general corporate planning.

This information starts the process.  Once the purpose for the valuation has been identified, the Standard of Value and Premise of Value is determined.

Standard of Value

Value is specifically defined for each situation; but the standard can be mandated by legal statute or regulation, such as by referencing US Generally Accepted Accounting Principles (GAAP) guidelines for financial reporting, impairment, or public company disputes. The standard of value is primarily one of the four following:

• Fair Market Value
• Fair Value (ASC 820)
• Fair Value (statutory)
• Investment Value

Fair Market Value  – is defined by Revenue Ruling 59-60 as the price at which the property would change hands between a willing buyer and a willing seller when the buyer is not under any compulsion to buy and the seller is not under any compulsion to sell – with both parties having reasonable knowledge of the facts. Fair Market Value is mandated for valuations to be reviewed by the Internal Revenue Service (estate and gift, deferred compensation, other tax related issues).  Similar definition of Fair Market Value or simply Market Value is also provided by the Department of Justice, FIRREA, and others.

Fair Value (ASC 820)  –  is defined as the price that would be received to sell an asset or the amount paid to transfer a liability in an orderly transaction between market participants at the measurement date. This Fair Value definition is required in all valuations performed under US GAAP or International Financial Reporting Standards (IFRS)

Fair Value (statutory)  –  is similar to Fair Market Value because it employs the same methodologies. It is often used in cases that are brought before the courts to determine the appropriate way to determine the value of a business when a “hypothetical sale” is not to be considered, such as in divorce or oppressed shareholder litigation. It can also be used to compensate a party for the involuntary use of an asset, such as eminent domain, where there is no reasonable assumption of a fair market value transaction.  In New Jersey, the generally accepted definition is:  “The Fair Value of shares should be the value of the eligible holder’s proportionate interest in the corporation without any discount for minority status – or absent extraordinary circumstances – lack of marketability”.  Most other states, such as Delaware, California, and Florida have their own definition based on case law.

Investment Value  – is defined as the value to a particular investor based on individual investment requirements and expectations.  Investment value valuations may take into account synergies of a specific buyer, or speculation relating to the possible increase in business value due to changes in technology, or other macro event.

Premise of Value

In addition to the Standard of Value, one further consideration is the premise of the valuation. This means knowing whether the valuation is for a going concern (the business will continue to operate with little or no change both prior to and immediately after the valuation date) or a scenario where the business will be liquidated.  This can be orderly where the business may continue to operate, and liquidation can take several months to two or three years, or it can be a forced liquidation, where the business will be shut down and all assets sold within a court-determined time period, usually less than three months.

It should be noted that the Going Concern Value is normally higher than the value of a liquidation. However, it is not always the case.  Under some circumstances, the liquidation value could be higher than that for a Going Concern. An example may be a golf course or a farm, where the value of the land re-purposed as a shopping or distribution center or a housing development is much more valuable than in its current use.

Because of the specificity of a business valuation, it has distinct purposes.  Valuations are often utilized for obtaining bank loans, distributing assets as gifts or in a divorce, estate planning, deferred compensation, or the purchase or sale of a business for general planning purposes.  The list of opportunities for performing a valuation is long, and the value obtained becomes essential especially when engaging in strategic corporate planning, determining a company’s sale price, during matrimonial disputes, when assessing intellectual property, or managing an estate.  Conferring with a qualified appraiser can help determine what type of appraisal is the right solution.

In Conclusion

For business owners or individuals who are undergoing a significant transition – such as a marital or business divorce, a shareholder dispute, a decision to merge or acquire a company, or even arrange financing – a valuation is the immediate initial step that must be undertaken to ensure an accurate and realistic basis for all future decision making.  

About the Author

Frank Merenda, CVA, ASA, BCA, CMEA, MBA, MSChE Managing Director, Sobel EAC Valuations LLC

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Business Valuation for Investors: Definition and Methods

What business valuations are and how to do them

What Is Business Valuation?

Why you would need to do a business valuation, business valuation methods, what business valuation means to investors, frequently asked questions (faqs).

Klaus Vedfelt / Getty Images

A business valuation is how the story of a company, its history, brand, products, and markets, is translated into dollars and cents. Valuations are used by investors, owners, bankers, and creditors, as well as the IRS, and the process can have very different results depending on the objective. Accurately calculating value is both an art and a science.

Here’s an overview of the how, why, and who of business valuations.

Key Takeaways

• All business valuations are estimates of economic value.
• A business valuation is influenced by who does it and why.
• Pricing and valuation are not the same thing.

Business valuation can be described as the process or result of determining the economic value of a company. All businesses have one thing in common: The goal is to generate profits for shareholders. Time frames, methods, and expectations differ, but the goal is the same.

Ultimately, the value of any business is the present value of expected future profits. The valuation process looks in depth at the operation, expenses, revenues, strategy, and risks of the business to arrive at assumptions for future earnings, time horizon, discount rates, and growth rates.

All business valuations are estimates. The objective of the valuation, and who does the analysis, heavily influences the end result. Investment bankers valuing a company to take it public want to justify the highest number possible, while accountants valuing a company for tax purposes want to arrive at the lowest number possible.

Valuation is different from pricing. Valuation is intrinsic; it’s based on the actual performance of the business. Pricing results from supply and demand; it incorporates market influences such as overall direction of prices, other investors, and new information such as rumors and news.

For an owner who may be looking for financing, considering a sale, or updating a financial plan, here are some common reasons for a business valuation.

Merger, Acquisition, and Financing Transactions

Valuations are fundamental to negotiations for the sale, purchase, or merger of a business. Valuations are used to benchmark buy-ins and buy-outs for partners and shareholders. Lenders and creditors often require valuations as a condition for financing. Valuations are also used to establish and update employee stock ownership plans (ESOPs).

Tax and Succession Planning

Valuations determine estate and gift tax liabilities and have an important role in retirement planning. Tax and succession valuations follow IRS guidelines.

Valuations are also often central to divorce proceedings, resolving partnership disputes, and settlements for legal damages.

Strategic Planning

The in-depth analysis of a business valuation can help owners better understand drivers of growth and profit.

The valuation method used depends on the condition of the business and the purpose of the valuation. The discounted cash-flow method is generally used for healthy companies generating a profit.

Discounted Cash Flow

The discounted cash flow method determines the present value of future profits, or earnings. The discount rate reflects the potential risk of the business not meeting profit expectations. A higher discount rate results in a lower value, which reflects a greater risk posed by the business. There are variations of the discounted cash flow method that use dividends, free cash flow, or other measures instead of earnings. The discounted cash flow method usually calculates the present value of five years of earnings adjusted for growth, and future earnings beyond five years (known as terminal value).

Net Asset, or Book, Value

The net asset value, also known as book value, is the fair market value of the business assets minus total liabilities on its balance sheet. Investors and lenders will consider net asset value for younger companies with limited financial histories. Net asset value is also useful as a lower limit for a valuation range, as it only measures a business’s tangible assets .

Liquidation Value

Liquidation value is the net asset value discounted for a distressed sale. Investors and lenders may consider liquidation value for younger or potentially distressed companies.

Market Value

The market value method is a relative method. It compares a company with its peers and within its industry to arrive at a value by using multiples like price-to-earnings ratio (P/E) . For example, one could value the Really Cool Fans Co. by applying an average P/E multiple for appliance stores to the company’s earnings like this:

Value = Price / Earnings Multiple 25 x earnings $120,000 = $3,000,000

The problem with using a relative method is that it incorporates any errors the market makes in valuing comparable companies as well as in the overall direction of prices.

Valuing a business is a complex process, and there aren’t any shortcuts. For the average investor, research reports can offer insights into a company’s value. The business valuation process is an in-depth analysis, yet at the same time, it’s only an estimate. 

A basic understanding of the valuation methods, however, can help you clarify your investment philosophy and strategy.

A true value investor analyzes stocks independently of the market, and looks for gaps between value and price. They believe that over time, price will catch up with value. Price investors look for market trends in the demand for a stock using technical analysis , then try to get ahead of those trends.

Efficient-market investors believe the market accurately reflects value. Value and price investors use active management styles, by selecting specific stocks with a goal of outperforming the market. Efficient market investors use passive investment styles, such as index funds.

Is the date of a business valuation important?

Yes, valuations for financial reporting and tax purposes have to be completed by a deadline. Valuations for mergers and acquisitions , financing, and other transactions have to meet the requirements of the parties involved.

What are the elements of a business valuation?

A business valuation can be thought of in terms of “why,” “how,” and “who.”

• Why is the objective of the valuation. Valuations done for different purposes will probably yield different results. 
• How is the valuation method selected. Different methods will produce different results.
• Who is the person or firm performing the valuation. Their experience and philosophy will influence the results.

What are common mistakes when valuing a business?

For the average investor, the biggest mistake is confusing pricing with valuation. Pricing considers demand, and valuation doesn’t. Pricing and valuation are both used to make investment decisions, but they’re different.

IRS. " IRS Revenue Ruling 59-60 ."

Patrick L. Anderson, Ilhan K. Geckil, and Nicole Funari. " The Three Essential Factors in Estimating Business Value or Commercial Damages ." AEG Working Paper 2007-1 .

National Association of Certified Valuators and Analysts. " Chapter Six - Commonly Used Methods of Valuation ." Page 7.

National Association of Certified Valuators and Analysts. " Chapter Six - Commonly Used Methods of Valuation ." Page 13.

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Understanding business valuation: what makes a company valuable.

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Founder & CEO of Financially Simple, LLC. An award-winning consultant, educator, best-selling author & keynote speaker. Follow his Journey.

Business valuations are often misunderstood. Most of us understand that when it comes to attracting customers, investors or buyers, increasing the intrinsic value of your business is crucial. But how do you increase that value? What makes your business truly valuable? The answer to these questions could be the key to unlocking your organization's value, making it an attractive commodity that could be sold for profit.

Price Versus Value—The Disconnect Between Owners And Buyers

Business owners often emphasize the price others will pay for their business. However, this is contrary to the view that prospective buyers and investors take. You see, buyers and investors are more focused on the value they'll get for their investment. This is because a business can be profitable without being valuable. In this situation, profits can suffer when one or more variables are changed or removed (in this case, the business owner). However, valuable companies are scalable and fully transferable.

Prospective buyers consider various factors, such as the viability of the business, quality of goods and services, intellectual property, customer base and the strength of the management team. This is why Warren Buffet wrote in a letter to his partners, "Price is what you pay. Value is what you get." From a buyer's perspective, building a business with high value ensures a higher price than the market may suggest.

However, it's also essential to grasp how a business valuation works from an appraiser's perspective. Because of this, I want to take a closer look at the three most common business valuation approaches used by appraisers.

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Best 5% interest savings accounts of 2024, three common business valuation techniques.

Let's take a look at the three most common valuation approaches.

1. The Market Technique

This technique involves using comparable company data to determine value. For large publicly traded companies, the guideline public company method analyzes stock prices of similar companies. However, for smaller private businesses, the guideline merger and acquisition (M&A) transaction method looks at sales of similar businesses within the industry. This method can be challenging due to limited public information.

2. The Asset Technique

The asset valuation technique assesses the value of tangible and intangible assets. The adjusted net asset value method calculates the value of assets and liabilities, while the excess earnings method evaluates intangibles. However, the latter is rarely used for sales valuation.

3. The Income Technique

Finally, the income technique is considered the most significant. It focuses on a company's income or cash flow and its associated risks. The capitalized historical cash flow method assesses past cash flow, while the discounted future cash flow method values projected future cash flows, considering the riskiness of those cash flows.

Why Business Valuation Matters

So, now you understand the three most common business valuation techniques. But why do they matter? Understanding each of these valuation methods is crucial because they impact your business's worth. Without knowing how a valuation works, you may as well be going through a maze with a blindfold on.

When you know the rules of the game you're playing, you can actually win. On the other hand, without this knowledge, growing your company's value for a profitable sale becomes quite challenging. By comprehending how appraisers value your business, you can identify the qualitative factors that drive its quantitative value.

In conclusion, business valuation is not just about numbers; it's about understanding what makes your company valuable in the eyes of investors and buyers. By understanding these valuation methods, you can strategically enhance your business's worth, setting the stage for a successful future.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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• Valuation Resources

A process of determining the worth of an asset, company, or investment based on various factors such as financial performance, market conditions, and future potential.

Finance and Business Analytics & Information Technology with a minors in Spanish and Earth & Planetary Sciences

What Is Valuation?

Understanding relative valuation, understanding absolute valuation, valuation analysis: discounted cash flow method, valuation analysis: comparables method, how earnings affect valuation.

• Things To Consider About Valuation

Determining a company's worth through an analytical process is known as “valuation.” Through a specific process there are many ways to conduct an evaluation.

Many factors come into play when looking at a company from a valuation perspective. This analysis includes the management of a business, capital structure composition , future profits that could potentially be made, and the worth of the assets of a business.

Another part of the process is fundamental analysis, which can be used alongside capital asset pricing and/ or dividend discount models.

It can be used in one favor if consent is provided to both parties of a transaction to evaluate a security’s fair value . This is meant by the price a buyer is ready to pay the seller. For example, the market value of a stock or bond is determined when buyers and sellers trade an item on an exchange.

However, intrinsic value is the assessment of a security's worth based on expected future profits or another aspect of the firm independent of the security's market price . In this case, evaluation is critical.

Analysts conduct valuations to evaluate if a firm or asset is over or undervalued by the market.

Types of valuation models include: 

Types of valuation methods include:

• Comparables method 
• Discounted cash flow method

Key Takeaways

• The analytical process of estimating the worth of a company or an object is called valuation. 
• An analyst evaluates a company based on several factors, such as the firm's management, the makeup of its capital structure, the likelihood of future earnings, and the market worth of its assets.
• Valuation objectives establish a firm's or asset's worth and compare it to the current market price.
• Valuation may be done to attract investors, sell or buy the business, dump assets or parts of it, release a partner, or transfer ownership to heirs, among other reasons.

The idea behind relative valuation , also known as valuation using multiples, is to compare an asset's price to the market worth of similar assets. The concept has produced useful tools in the securities investing space that are likely able to identify pricing abnormalities.

As a result, analysts and investors are now better equipped to make critical judgments on asset allocation thanks to these tools.

When valuing an asset, relative valuation—also known as comparable valuation—is a very helpful and efficient method. 

For instance, a bond's valuation involves comparing its price to a benchmark , typically a government bond. In this case, the bond's "required return"—technically, its yield to maturity , or YTM —is ascertained by comparing its credit rating to that of a government asset with a comparable maturity.

The bond's YTM difference from the benchmark's YTM is inversely correlated with bond quality.

Absolute methods only consider the fundamentals in their search for an investment's intrinsic or true value. The fundamental analysis disregards every other company and focuses on one specific business's dividends, cash flow , and growth rate.

The discounted cash flow , dividend discount, asset-based, and residual income models are examples of models included in this category.

By predicting the future income streams of enterprises, absolute assessment models determine their current value. The models determine a company's intrinsic or true worth using the data included in its financial statements and books of accounts.

The absolute assessment technique is reductive since it isolates the company's attributes for study. It doesn't allow for comparison to rivals in the same field or related fields.

The method is challenging, though, because competition analysis is crucial for gauging the general market trend in a certain industry.

Disruptive innovation brought on by new technology, sizable mergers and acquisitions , regulatory change, new market entrants, or bankruptcy may impact an industry's future.

Different methods are as follows:

• Discounted Cashflow Method:  The DCF model analyzes projected payments and sums due shortly and applies a formula to determine a company's rate of return. The result is a forecasted cash flow, which may be used to determine how long the business can maintain a growth trajectory.
• Dividend Discount Model:  According to the Dividend Discount Model, future dividends generated by any company's securities after being discounted to their present value serve as a realistic representation of the intrinsic worth of that company's business.

A corporation can be valued in various ways. Discounted cash flow assessment is a typical approach. Companies frequently utilize Discounted cash flow assessments to show investors the present value of their firm. It is also employed to value investments.

Business owners must comprehend how the Discounted cash flow ( DCF ) business approach functions and its advantages.

DCF assessment method determines the value of a business or investment using anticipated future cash flows. Therefore, anyone looking for a more accurate evaluation of an investment opportunity might benefit from knowing how to calculate the present value of an investment using DCF.

This computation generates predictions about the potential future profitability of an investment by evaluating several aspects, such as possible future expenses and advantages.

DCF method is used in investment banking to calculate the possible real value return on investment .

The Discounted Cash Flow method is one of the various methods used to value a corporation. It can also be paired with another method for more accurate results.

The time value of money  hypothesis  states that money’s worth increases with time because it may be invested. A dollar entering or leaving a company today is thus worth more than it will be later.

The entire worth of a firm may be determined using a DCF valuation. This aids in the better understanding of an organization's value by investors and corporate finance experts.

The entire cash flow for each financial period is multiplied by one in the DCF calculation, and the discount rate is applied .

Each year, a company or investment has cash available for several uses, such as reinvesting in the business or more basic ones, like paying employees and regular expenses.

Future earnings and costs are discounted by a certain proportion to reflect their current value. This rate represents the company's cost of capital , also known as the profit the company has to make to pay for capital investment.

Examples include loan and interest payments , dividends paid to shareholders, and interest rate payments. The weighted average cost of capital serves as their normal basis.

By adding up, one may determine the net present value of an investment opportunity over a certain period. The higher the NPV , the more valuable the project or investment.

The lower this number, the more challenging it will be to see a profit. With this method, you must predict a company's cash flows, choose a suitable discount rate, and compute an NPV that fairly represents the project's or investment opportunity's financials.

One of the most popular approaches to stock valuation is the comparables technique. This strategy compares relevant assessment metrics and evaluates comparable firms.

The comparables approach is frequently one of the simpler assessment techniques as long as the firm being valued is comparable to other publicly traded companies.

Comparable enterprises and their operational outcomes are the foundation of the comparables approach to equity. Using financial information from other firms, you may assess how a company performs against competitors and peers in the same industry.

This is one method of determining if a corporation is valued adequately, fairly, or according to size.

Comparing a company to its main competitors, or at the very least those that run similar operations, is necessary to estimate the comparable process.

Value variations between similar businesses may create a business opportunity. Since this shows that the stock is cheap, it may be bought and held until its value increases.

If the contrary is true, there may be a chance to short the stock or set up one's portfolio to benefit from a decrease in its price.

Analysts can also examine a company's margin levels to better understand how it compares to competitors.

An activist investor would argue that a company with averages below those of its rivals is poised for a turnaround and should see a value increase in the future.

The comparables approach of equity is based on information readily available regarding comparable companies . Therefore, the entity being compared must have comparable businesses, and those comparable businesses must have publicly accessible information.

If one of those conditions still needs to be met, it could be challenging or impossible to gather comparable data properly.

The price-to-earnings ratio measures a company's success by contrasting the share price with its earnings per share . The price-to-earnings ratio is also known as the price multiple and the earnings multiple.

Analysts and investors use price-to-earnings ratios to analyze the relative worth of a company's shares on an apples-to-apples basis. It may also be used to compare several broad markets throughout time or the present performance of a corporation to its previous performance.

One of the methods that analysts and investors use the most frequently to assess the relative value of a business is the price-to-earnings ratio. The P/E ratio of a stock may be used to determine if it is overvalued or undervalued.

A company's P/E ratio may also be related to other businesses in its industry or the market as a whole, like the S&P 500 Index.

Based on the earnings accessible to Common Shareholders divided by the number of Outstanding Common Stock Shares, the earnings per share is calculated.

Earnings Per Share is a metric for assessing a company's profitability since, for investors, a share of a company that can generate larger earnings per share is more valuable.

When a stock's P/E ratio, for example, is x times earnings, an analyst compares it to other companies in the same industry and the overall market's ratio.

Equity research employs a multiples-based, or multiples approach, method when a firm is valued using ratios like the P/E ratio. Then, other multiples are compared to those of comparable businesses in the past to determine intrinsic value .

Things to Consider about Valuation

Various stock methodologies accessible to investors might rapidly overwhelm someone choosing one to evaluate a business for the first time. Although some assessment techniques are quite simple, others are more difficult and sophisticated.

Considering these factors holistically can help stakeholders arrive at a more informed and realistic valuation.

• Financial Performance : A key component of valuation is the historical and anticipated financial performance of the company. Metrics that reveal the company's capacity to make profits include cash flow, profitability, and revenue growth.
• Competitive Advantage and Market Positioning: It is critical to comprehend the company's advantages over competitors as well as entry obstacles. Valuation is influenced by elements including market share , brand strength, and distinctive value propositions.
• Growth Potential: It's critical to assess the company's potential for expansion and scalability. Valuation is influenced by variables like market size, room for growth, and possibility for innovation.
• Risk assessment: It's crucial to identify and reduce risks related to the company, the market, and the industry. Operational risks, competitive challenges, and regulatory compliance are a few examples of factors that affect valuation.
• Exit Strategy and Market Sentiment: When estimating valuation, it's critical to take investor sentiment and the exit strategy into account. Decisions on valuation are influenced by a number of factors, including investor appetite, the state of the market, and the timing and mode of exit.

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Run » finance, what is a business valuation and how do you calculate it.

There are multiple ways to find the economic value of your business, with different calculations that can be used for different purposes.

How do you put a price on the time, effort and passion you’ve put into building a successful small business? It can be hard to objectively assess how much your venture is worth after putting so much work in over the years. This is where business valuation calculations, ideally handled by a third-party expert, can play a role. Business valuations are used for mergers, acquisitions, tax purposes and more. Here’s how business valuations work and how to calculate the economic value of your company.

[Read more: 3 Things to Consider When Selling a Business During a Pandemic ]

What is a business valuation?

A business valuation assesses the economic value of part or all of a business. Business valuations are used in a number of circumstances, including to determine the sale value of a business, to establish partner ownership, for tax purposes or even in divorce proceedings.

Generally, the valuation process analyzes all aspects of the business, including the company’s management, capital structure, future earnings and the market value of its assets. In the United States, business valuations are usually carried out by a professional who is Accredited in Business Valuation (ABV). This certification, awarded by the American Institute of Certified Public Accountants, is given to CPAs who pass an exam and meet minimum standards set by the AICPA.

If you’re seeking financing from lenders, investment bankers or venture capitalists, you may need an ABV-certified professional to help carry out your business valuation. If you’re simply looking to understand how much your venture is worth, you can carry out your own analysis using one of the business valuation methods listed below.

[Read more: How to Calculate a Business Valuation ]

Business valuation methods

There are three common methods to evaluating the economic worth of a business. These categories are:

• Asset-based methods : Sum up all of the investments in the company to determine the value of the business.
• Earning value methods : Evaluate the company based on its ability to produce wealth in the future.
• Market value methods : Estimate what the company is worth based on similar businesses that have recently been sold.

In general, try to use more than one method to get the most accurate depiction of your business value.

There are pros and cons to each of these approaches to valuation. An asset-based approach, for instance, works well for corporations in which all assets are owned by the company and will be included in the sale. But, for a sole proprietor, this approach can be more difficult; which assets should be considered personal, versus business-related?

Generally, the two main earning value methods — capitalizing past earnings and discounted future earnings — are used when a company is seeking to buy or merge with another company. Market-value approaches are the least accurate and can lead to a business being under- or overvalued.

How to calculate a business’s value

Often, business valuations are performed by a licensed professional. To find an ABV who can help, look for someone registered with the American Society of Appraisers (ASA).

If you’re simply looking to get a basic idea of what your business is worth, there are a few steps you can take to get a rough estimate. Start by calculating your seller’s discretionary earnings (SDE) . SDE is like EBITDA, with owner’s salary and owner’s benefits added back in. “Start with your pretax, pre-interest earnings. Then, you’ll add back in any purchases that aren’t essential to operations, like vehicles or travel, that you report as business expenses. Employee outings, charitable donations, one-time purchases and your own salary can all be included in your SDE,” wrote NerdWallet .

Once you have your SDE, take stock of your assets, do a little market research to see similar businesses have sold for, and pay attention to industry trends to see if you can ask for a higher valuation.

In general, try to use more than one method to get the most accurate depiction of your business value. “A general rule of thumb in business valuation is that you will want to use multiple methods. Using three to four methods will allow you to estimate fair value with more accuracy,” wrote the experts at The Balance .

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Business Valuation - Explained

What is business valuation.

Business valuation refers to the general process of ascertaining the economic value of a company unit or a whole business. Business valuation can be utilized in ascertaining a business' fair value for various reasons, with the inclusion of sale value, taxation, divorce proceedings, and establishing partner ownership. Owners would often consult professional business evaluators for an objective estimate of the business' value. Important: Estimating a business' fair value is an art, as well as a science. Several formal models exist which can be utilized, but picking the right one, as well as, the appropriate inputs can be somewhat subjective.

How Does Business Valuation Work?

What are business valuation methods, asset-based (or cost-based) valuation methods.

The asset-based approach focuses on the valuation of the firms assets or, in some instances, the cost of replacing those assets. This approach puts emphasis on the total assets and liabilities of the firm. It therefor reflects a whole-firm valuation, rather than simply an equity valuation. To identify the equity value of the firm, one subtracts the market value of any debt held by the company. Determining the valuation may also require adjustment for the intangible assets of the firm that may be incapable of replacement. Asset-based valuation has many variables based upon the purpose or type of company being valued. Common asset-based valuations include:

Market-based Valuation Approaches

Market-based approaches value the business based upon the productive characteristics of the business in a given market. These methods focus on comparisons of like businesses, transactions, or industries (known as comparables or comps). Most of these methods focus on identifying a value-based, characteristic of the comparable and comparing it to the total price or value of the firm (i.e., Value-based Characteristic / Total Value of Outstanding Share). The ratio of this value-based characteristic to price is used to value businesses with similar productive output, involved in similar transactions (the reason for valuation), or operating within the same industry. In summary, these methods attribute a value to a business by using ratios (value characteristic to price) to compare the firm being value with other firms whose value is readily determined.

What are Income-Based Valuation Approaches?

Hybrid methods of valuation    , related articles.

Business valuation: Understanding the most common approaches

March 20, 2023 ⋅ 9 min read

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We talk to a lot of business owners who have spent decades building impactful companies that their communities rely on.

However, the value of a business will increase or decrease over time depending on how the business performs. Knowing your company's value at any given time can be very helpful, especially when looking to appeal to investors or plan for retirement.

If you’re looking to get a business valuation, there are different approaches you can use to value your company.

Read on to learn the most common business valuation approaches and what they entail.

Why is business valuation important?

Business valuation is essential for understanding your company's health at any given time. And it's also important when you want to sell your business as it helps guide your pricing. Moreover, business valuation is essential when:

Securing funding from investors

Planning for retirement

Making strategic decisions

Increasing the value

Creating employee stock ownership plans (ESOPs)

Determining the estate tax value of a family-owned business

Related: Insightful questions to ask a business broker before selling your business

What are the most common business valuation methods?

Now that you know the purpose of business valuation, it's time to look into the various methods of valuation you can use.

The good thing about these strategies is that you don't have to be a financial expert to find the true value of your business. At Baton, we use various methods and consider your business' industry, location, size, and other unique factors to get you an accurate valuation estimate powered by your own financial data .

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1. discounted cash flow (dcf).

Discounted cash flow (DCF) analysis is a popular method used by investors to estimate the value of a business.

The idea behind DCF analysis is that the value of a company is equal to the present value of its future cash flows. So, you discount the business's projected future cash flows by using a risk-adjusted discount rate. This gives you the business's net present value (NPV).

The downside of using this method is that it relies on several subjective assumptions. These include estimating future cash flows, choosing the right discount rate, and estimating the company's terminal value.

Some of the pros of using DCF analysis include:

It's useful for businesses with long-term contracts or high-growth potential

It takes a comprehensive view of the business by considering all cash flows

The cons of DCF analysis include the following:

It's difficult to estimate future cash flows accurately

It relies on too many subjective assumptions

You should use the DCF method when:

You're a long-term investor

The business has a high growth potential

You want to value the entire cash flow stream of the business

The DCF method is an income-based approach that looks at a company's future cash flows to determine its value. Therefore, it differs from other valuation methods, which may use earnings or book value measures.DCF analysis considers the time value of money, meaning that a dollar today is worth more than a dollar tomorrow. One of the reasons for this is that you can invest a dollar today and earn interest on it, while a dollar tomorrow wouldn’t have had that opportunity.

This is why the discount rate used in DCF analysis is so important. It's the rate used to convert future cash flows into their present value. The higher the discount rate, the less valuable future cash flows become.

It's also important to note that DCF analysis doesn't just look at the business's future cash flows. It also considers the cash flows of its competitors.

This is known as the "component method." By doing this, DCF analysis can give you a more accurate picture of a business's worth.

Capitalization of earnings valuation method

The capitalization of earnings valuation method is another income-based approach. With this method, you determine a company's value by looking at its past earnings and estimating its future earnings potential. You then divide the company's current earnings by an appropriate rate to get its value.

This rate is known as the "capitalization rate." It's similar to the discount rate used in DCF analysis but not as complex.

The capitalization of earnings valuation method is a simple way to value a company. However, it has its drawbacks. One is that it only looks at historical earnings. So, it doesn't take into account a company's future potential.

Another drawback is that it relies on the "earnings power value" ( EPV ) method. Therefore, it only looks at a company's earnings before interest, taxes, depreciation, and amortization (EBITDA). Such an approach can be misleading, as it doesn't consider a company's cash flow.

The main advantage of the capitalization of earnings valuation method is that it's easy to use. You can quickly estimate a company's value by looking at its past earnings. You should use the capitalization of earnings valuation method when:

You want a quick estimate of a company's value

The company has a long history of stable earnings

You're comfortable using the EPV method

2. Multiples valuation method

The multiples valuation method is a comparative approach. It values a company by looking at similar companies.

With this method, you compare a company's financials to the financials of similar companies. You then use these ratios to determine the value of the company you're trying to value.

This method is sometimes referred to as the "comparable companies analysis" or the "trading comps method."The advantage of the multiples valuation method is that it's easy to use. You can quickly estimate a company's value by looking at similar companies. The disadvantage of this method is that it's based on comparisons. This means it can be challenging to find comparable companies. It can also be difficult to find accurate financial information for these companies.

You should use the multiples valuation method when:

You're comfortable using comparisons

You can easily find comparable companies

Baton has a database of over 4 million companies with valuations, exits, and more to guide you through the valuation process.

3. Asset-based valuation

The asset-based valuation method is a balance sheet approach. This means it values a company by looking at its assets and liabilities.

This method calculates a company's value by subtracting its liabilities from its assets. This gives you the company's net worth or "book value."The advantage of the asset-based valuation method is that it's easy to use. You can quickly estimate a company's value by looking at its balance sheet.

The disadvantage of this method is that it doesn't consider a company's earnings potential. This means it could undervalue a company with a lot of growth potential.

You should use the asset-based valuation method when:

Valuing companies in specific sectors like used car dealerships

Liquidating

4. Future maintainable earnings valuation method

The future maintainable earnings valuation method is a top-down approach. This means it values a company by looking at its future earnings potential.

In essence, FME is a simplified version of the Discounted Cash flow method. It's an ideal option when you expect profits to remain steady for the foreseeable future. Moreover, small businesses generally lack sufficient information for DCF models.

With this method, you look at the company's industry and market. You then use this information to estimate the company's future earnings.

The advantage of the future maintainable earnings valuation method is that it accounts for a company's future potential. This means it could be more accurate than the other methods.

The disadvantage of this method is that it's more challenging to use. First, you need to understand the company's industry and market well. You also need to make estimates about the company's future earnings.

You should use the future maintainable earnings valuation method when:

You want a more accurate estimate of a company's value

You have a good understanding of the company's industry and market

You're comfortable making estimates about the company's future earnings

Which is the most used approach in business valuation?

SDE multiples for SMBs are the most widely used approach for business valuations. This is a quick and easy way to value a company by looking at similar companies. It's also based on the EPV method, which is widely used in business valuation.

The main advantage of using SDE multiples is that it's easy to find comparable companies. It's also quick to estimate a company's value using this method.

The disadvantage of using SDE multiples is that it doesn't consider a company's future potential. This means it could undervalue a company that has high growth potential.

What are the limitations of business valuation methods?

The main limitation of business valuation methods is that they're based on estimates. This means there's always a margin of error when valuing a company.

Another limitation is that valuation methods only give you an estimate of a company's value. They can't tell you what the company is actually worth.

The best way to overcome these limitations is to use multiple valuation methods. This will give you a range of values for the company. You can then use this information to decide on its value.

What is the best method for valuing a company?

The best method for valuing a company depends on different things. These include the goals of the valuation and the type of company being valued.

Here are some of the valuation methods you may consider for different scenarios:

When you want to liquidate your company

An asset-based valuation method is a good option when you want to liquidate your company. You can quickly estimate a company's value by looking at its balance sheet.

If you're valuing a company with a lot of growth potential

The DCF method is a good option. This method takes into account a company's future potential and can give you a more accurate estimate of its value.

To get a highly accurate valuation

A discounted cash flow analysis is the best option. This method accounts for a company's future earnings and cash flows to accurately estimate its value.

A quick estimate of a company's value

The multiples valuation method is a good option. You can quickly get an estimate of a company's value by looking at similar companies.

As you can see, different valuation methods are best suited for varying situations. As such, the best method for valuing a company depends on the specific goals of the valuation and the type of company being valued.

Why you need a business valuation

Business valuation approaches are a helpful tool for determining the value of a company. However, they should not be used as the only source of information when making a final decision about a company's value.

Instead, it is essential to use multiple valuation methods to get a more accurate estimate of a company's worth. By doing so, you can make an informed decision about whether or not to invest in the business.

Are you looking to sell or purchase a business? If so, you need an accurate business valuation to help you get maximum value on your investment. This is where Baton can help. We offer business valuation solutions to both buyers and sellers. Sign up to get started today.

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Business Valuation is a comprehensive process used to determine the economic value of a whole business or company unit, based on factors like its asset value, market position, and future earnings potential.

A business valuation involves assessing various elements of the business to estimate its selling price or value for different purposes, such as investment analysis, business sales, or mergers and acquisitions. For entrepreneurs and business owners, understanding business valuation is key to making informed decisions about their company’s future and financial health.

Valuation Methods

Asset-based approach (also known as book valuation).

The Asset-Based Approach, often referred to as “Book Valuation,” focuses on the value of a company’s assets. It involves totaling the value of all the company’s tangible and intangible assets and then subtracting its liabilities. This approach is most applicable to companies with significant physical assets.

Income Approach (Also Known as Discounted Cash Flow (DCF) Analysis)

The Income Approach, frequently termed as “Discounted Cash Flow (DCF) Analysis,” estimates a company’s value based on its expected future cash flows. These cash flows are then discounted back to their present value, using a discount rate that reflects the risk of the cash flows. This method is particularly useful for companies with stable and predictable cash flows.

Market Approach

The Market Approach values a company by comparing it to similar companies that have been sold or are publicly traded. This approach is especially relevant for businesses operating in industries with a large number of comparable companies and transactions.

Hybrid Approach

A Hybrid Approach combines elements of the asset-based, income, and market approaches to provide a more comprehensive valuation. This method is particularly useful when each individual approach has limitations due to the unique characteristics of the business being valued. For instance, a business might have significant physical assets (favoring an asset-based approach), stable cash flows (suitable for the income approach), and comparable companies in the market (aligning with the market approach). By integrating these methods, the hybrid approach offers a balanced and nuanced valuation, considering multiple facets of the business’s value.

Application in Business Valuation

In practice, the choice of valuation method depends on the nature of the business, the purpose of the valuation, and the availability of data. For instance, startups with limited financial history might not find the income approach as effective, whereas established companies with significant physical assets might lean towards the asset-based approach. The hybrid approach can be particularly useful in complex valuation scenarios where a single method may not capture the full picture of a company’s value.

Using a combination of these methods can provide a more rounded and accurate estimation of a company’s worth, essential for strategic decision-making, investment analysis, and transactions such as mergers and acquisitions.

Valuation Professionals:

Certified Valuation Analysts (CVAs), Accredited Senior Appraisers (ASAs), and other valuation professionals play a crucial role in the business valuation process. They provide expertise, objectivity, and standardized methods to ensure a fair and accurate valuation, especially in complex scenarios or legal proceedings.

Frequently Asked Questions

• When should a business consider getting a valuation?

A business should consider getting a valuation in several scenarios, such as when contemplating a sale or merger, seeking investment, planning for taxes, or during legal proceedings involving asset division. It’s also useful for strategic planning and understanding the financial growth or trajectory of the company.

• How can the choice of valuation method impact the estimated value of a business?

The choice of valuation method can significantly impact the estimated value of a business as each method focuses on different aspects of value. For instance, the asset-based approach might yield a different value compared to the income or market approach, as it focuses on tangible assets rather than earnings potential or market comparables. The appropriate method depends on the nature of the business and the purpose of the valuation.

• Why is it important to engage professional valuation services?

Engaging professional valuation services is important to ensure accuracy, objectivity, and compliance with legal and financial standards. Professional valuators have the expertise to apply the most suitable valuation methods and consider all relevant factors, resulting in a more reliable and credible valuation. This is especially crucial in high-stakes situations like legal disputes, significant business transactions, or complex financial planning.

• What is a valuation multiple and how is it used in business valuation?

A valuation multiple is a financial metric used to estimate a business’s market value relative to a key financial statistic, such as earnings, sales, or assets. Common examples include price-to-earnings (P/E) ratio, enterprise value-to-sales (EV/Sales), and enterprise value-to-EBITDA (EV/EBITDA). These multiples are derived from market comparisons and are used to value a business by applying the multiple to the corresponding financial metric of the business being valued. They are particularly useful in the market approach to business valuation.

• Can a brand-new company be valued, and what factors contribute to its valuation?

In most cases, a brand-new company without operational history or financials may not have a significant established value. However, its potential value can be determined based on factors such as the entrepreneur’s experience, the uniqueness of the business idea, market potential, intellectual property, and anticipated future cash flows. While it’s challenging to assign a concrete value to a new company, these factors can provide investors or founders with an initial estimation of its potential worth.

• How is the valuation of a brand-new company typically determined?

The valuation of a brand-new company is often determined by projecting its future cash flows and then discounting them to their present value using an appropriate discount rate (as in the Discounted Cash Flow Analysis). This method is predicated on the expectation that the company will generate positive cash flows in the future. Other factors, like market demand for the product or service, the strength of the business plan , and the experience of the management team, also play a crucial role in this valuation process. For very early-stage companies, valuation may also be influenced by comparable transactions in the industry or by the amount of capital the founders need and the amount of equity they are willing to give up.

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For Investors: Business Valuation 101

Here's how and why to determine the valuation of a business..

Business valuation is an educated guess at what an entire business would sell for on the open market. It doesn't matter if you're an income investor seeking dividend yields to provide cash in retirement, a venture capital-level high-growth investor, or a traditional value investor focusing on out-of-favor stocks. If you ignore business valuation, you do so at your peril.

When we buy stocks , our shares represent fractions of a business. Over the short term, stock price movements can seem random because they're driven more by emotion. But, over the long term, stock prices are driven by the compounding value of the business that the stock represents.

Let's go over what business valuation is and how to calculate it.

What is business valuation?

Business valuation is the process of estimating what it would cost an independent buyer to purchase the entire business. This means estimating what the future earnings of the business are worth to the buyer, comparing similar business sales, or estimating the value of the business if the assets were sold off piecemeal.

Before proceeding, here's a common saying pertinent to investing: "Business valuation is like the Hubble telescope. Move it an inch and you're in a totally different galaxy."

No matter which of the techniques described below you use, it's important to remember there's no perfect valuation method. Business valuation can be easily influenced by our innate biases. As with any model, GIGO (garbage in, garbage out) applies.

Estimating business value is important for determining whether your purchase will have a margin of safety. Suppose you buy a high-growth stock for $50/share and it's only worth $40/share. (This price is often referred to as the business's intrinsic value .) You don't have room for error.

On the other hand, if you buy a stock worth $100/share for $50/share, it's already trading so low that it is relatively unlikely that bad news will crush your pick. Investors who focus on stocks with a high margin of safety and wait for the stock price to revert to its intrinsic value are called value investors .

Methods of business valuation

Let's walk through the most popular valuation techniques and discuss the strengths and weaknesses of each.

Market cap is equal to the current price of the stock multiplied by the number of shares. It tells you the amount it would currently take to purchase the whole business.

Many analysts prefer to adjust the market cap number to get enterprise value (EV) , which is the market cap plus total debt minus cash. Enterprise value is a more accurate representation of what it would cost to purchase the business because it includes cash the buyer would receive and debts that they would be liable to pay.

Discounted cash flow

The most common valuation method for professional investment bankers and research analysts is the discounted cash flow (DCF) model . This model projects future cash flows that the business will earn and then discounts them back to a present value.

The first part should be intuitive. The value of a business is equal to the future earnings that it generates for owners. The problem is that money is worth more to us now than it is in the future.

Money that we have now can be invested and compound to a much higher amount in the future. We use a discount rate in the model to give less value to the cash flow that is projected to occur further into the future.

The DCF is the valuation method most ripe for abuse. As you can imagine, it is easy to estimate far higher growth than a business is truly capable of or use a discount rate that is lower than it should be. Each change to the model's inputs includes the opportunity to create a worse intrinsic value calculation.

Comparables

Comparables is another popular valuation method. You compare to the subject business either what comparable companies currently trade for on the stock market or what they have sold for in recent mergers or acquisitions.

The first step is to identify an industry standard price multiple that you can use for comparison. Here are some of the most common multiples:

• Price/Earnings: The P/E is equal to the current stock price divided by the current earnings per share (EPS) . This multiple is commonly used as a back-of-the-envelope comparison for stocks with strong earnings power.
• EV/EBITDA: The EV/EBITDA ratio is used to compare companies that have different capital structures because EBITDA , which stands for earnings before interest, taxes, depreciation, and amortization, doesn't include capital costs.
• Price/Sales: The P/S ratio is used for high-growth companies that are spending so much money on growth that they don't have earnings to speak of.
• Price/Book: Book value is equal to the business's assets minus liabilities. It is also called shareholder's equity. Price/book is used for asset-intensive business such as real estate investment trusts ( REITs ) or banks .

Once you determine which multiple to use, gather the multiples of comparable businesses and find the average. That average can be applied to the subject stock to find an intrinsic value.

For example, let's say you want to value a high-growth stock. You would pick three businesses in the same industry growing at similar rates and find their average P/S ratio. Multiply that number by the subject's sales, and you have an estimated market cap.

Comparable analysis may not seem as scientific as a full-blown DCF spreadsheet, but for many investors it is a more useful analysis. Negotiation between businesses and buyers are usually done with multiple analyses. While DCFs can be easily manipulated, the multiple of every comparable business can't be.

Liquidation value

Liquidation value is typically only used for failing asset-heavy businesses. It is the value to an investor if every debt was paid off and every asset sold in a fire sale. To start the analysis, the value of each asset is adjusted to account for the price it could fetch in a sale:

• Cash: Cash is generally given 100% of its balance sheet value for obvious reasons.
• Accounts Receivable (ARs): ARs are often discounted by as much as 50% to 80%. It takes time and money to track down customers. Most buyers simply sell the ARs to a collection agency for a fraction of their balance sheet value.
• Inventory: If inventory is given any value, it's only 10% of the balance sheet amount. It's notoriously difficult to sell the inventory of a failing business for anything close to market price.
• Property, Plant, & Equipment (PPE): PPE values need to be determined on a case-by-case basis. A forklift that crashed into a wall is worth far less than its balance sheet value, while a building that was purchased 40 years ago and has been fully depreciated is worth far more.

After finding an adjusted asset value, subtract the value of all liabilities. The result is the liquidation value of the business.

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Valuation should be simple

While Warren Buffett has written about the virtues of the DCF model, his longtime business partner, Charlie Munger, once remarked that he doesn't think he's ever actually seen Buffett do one. The more complicated a valuation technique is, the more likely it is to experience the GIGO problem.

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How to Write a Business Plan: Your Step-by-Step Guide

So, you’ve got an idea and you want to start a business —great! Before you do anything else, like seek funding or build out a team, you'll need to know how to write a business plan. This plan will serve as the foundation of your company while also giving investors and future employees a clear idea of your purpose.

Below, Lauren Cobello, Founder and CEO of Leverage with Media PR , gives her best advice on how to make a business plan for your company.

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What is a business plan, and when do you need one?

According to Cobello, a business plan is a document that contains the mission of the business and a brief overview of it, as well as the objectives, strategies, and financial plans of the founder. A business plan comes into play very early on in the process of starting a company—more or less before you do anything else.

“You should start a company with a business plan in mind—especially if you plan to get funding for the company,” Cobello says. “You’re going to need it.”

Whether that funding comes from a loan, an investor, or crowdsourcing, a business plan is imperative to secure the capital, says the U.S. Small Business Administration . Anyone who’s considering giving you money is going to want to review your business plan before doing so. That means before you head into any meeting, make sure you have physical copies of your business plan to share.

Different types of business plans

The four main types of business plans are:

Startup Business Plans

Internal business plans, strategic business plans, one-page business plans.

Let's break down each one:

If you're wondering how to write a business plan for a startup, Cobello has advice for you. Startup business plans are the most common type, she says, and they are a critical tool for new business ventures that want funding. A startup is defined as a company that’s in its first stages of operations, founded by an entrepreneur who has a product or service idea.

Most startups begin with very little money, so they need a strong business plan to convince family, friends, banks, and/or venture capitalists to invest in the new company.

Internal business plans “are for internal use only,” says Cobello. This kind of document is not public-facing, only company-facing, and it contains an outline of the company’s business strategy, financial goals and budgets, and performance data.

Internal business plans aren’t used to secure funding, but rather to set goals and get everyone working there tracking towards them.

As the name implies, strategic business plans are geared more towards strategy and they include an assessment of the current business landscape, notes Jérôme Côté, a Business Advisor at BDC Advisory Services .

Unlike a traditional business plan, Cobello adds, strategic plans include a SWOT analysis (which stands for strengths, weaknesses, opportunities, and threats) and an in-depth action plan for the next six to 12 months. Strategic plans are action-based and take into account the state of the company and the industry in which it exists.

Although a typical business plan falls between 15 to 30 pages, some companies opt for the much shorter One-Page Business Plan. A one-page business plan is a simplified version of the larger business plan, and it focuses on the problem your product or service is solving, the solution (your product), and your business model (how you’ll make money).

A one-page plan is hyper-direct and easy to read, making it an effective tool for businesses of all sizes, at any stage.

How to create a business plan in 7 steps

Every business plan is different, and the steps you take to complete yours will depend on what type and format you choose. That said, if you need a place to start and appreciate a roadmap, here’s what Cobello recommends:

1. Conduct your research

Before writing your business plan, you’ll want to do a thorough investigation of what’s out there. Who will be the competitors for your product or service? Who is included in the target market? What industry trends are you capitalizing on, or rebuking? You want to figure out where you sit in the market and what your company’s value propositions are. What makes you different—and better?

2. Define your purpose for the business plan

The purpose of your business plan will determine which kind of plan you choose to create. Are you trying to drum up funding, or get the company employees focused on specific goals? (For the former, you’d want a startup business plan, while an internal plan would satisfy the latter.) Also, consider your audience. An investment firm that sees hundreds of potential business plans a day may prefer to see a one-pager upfront and, if they’re interested, a longer plan later.

3. Write your company description

Every business plan needs a company description—aka a summary of the company’s purpose, what they do/offer, and what makes it unique. Company descriptions should be clear and concise, avoiding the use of jargon, Cobello says. Ideally, descriptions should be a few paragraphs at most.

4. Explain and show how the company will make money

A business plan should be centered around the company’s goals, and it should clearly explain how the company will generate revenue. To do this, Cobello recommends using actual numbers and details, as opposed to just projections.

For instance, if the company is already making money, show how much and at what cost (e.g. what was the net profit). If it hasn’t generated revenue yet, outline the plan for how it will—including what the product/service will cost to produce and how much it will cost the consumer.

5. Outline your marketing strategy

How will you promote the business? Through what channels will you be promoting it? How are you going to reach and appeal to your target market? The more specific and thorough you can be with your plans here, the better, Cobello says.

6. Explain how you’ll spend your funding

What will you do with the money you raise? What are the first steps you plan to take? As a founder, you want to instill confidence in your investors and show them that the instant you receive their money, you’ll be taking smart actions that grow the company.

7. Include supporting documents

Creating a business plan is in some ways akin to building a legal case, but for your business. “You want to tell a story, and to be as thorough as possible, while keeping your plan succinct, clear, interesting, and visually appealing,” Cobello says. “Supporting documents could include financial projects, a competitive analysis of the market you’re entering into, and even any licenses, patents, or permits you’ve secured.”

A business plan is an individualized document—it’s ultimately up to you what information to include and what story you tell. But above all, Cobello says, your business plan should have a clear focus and goal in mind, because everything else will build off this cornerstone.

“Many people don’t realize how important business plans are for the health of their company,” she says. “Set aside time to make this a priority for your business, and make sure to keep it updated as you grow.”

What is cash value?

Types of cash value life insurance, benefits of cash value life insurance.

• Considerations before choosing

Cash value life insurance FAQs

Cash value life insurance: build savings and protection.

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• Cash value is money that accumulates on a permanent life insurance policy, which can build wealth.
• Policyholders can use their cash value to invest, save, or even borrow.
• Cash value grows differently depending on the type of permanent life insurance you choose.
• Compare life insurance quotes with Policygenius .

Cash value is a feature unique to permanent life insurance policies , which offers coverage for your entire life. Unlike your death benefit, you can use your cash value during your lifetime as you see fit. However, using your cash value can impact your death benefit and have tax consequences. It's important to understand the terms and conditions of your policy, including any fees or penalties associated with accessing the cash value and the tax consequences of withdrawals or loans.

Cash value is money that accumulates as you pay your monthly premium on a permanent life insurance policy. You can use this money to save or invest, which increases your policy's value over time. This adds an addition dimension to permanent life insurance policies, letting policyholders get some use out of their life insurance policy while they're still living. 

How cash value accumulates

You have to pay a premium to maintain your permanent life insurance policy, much like a subscription service or utilities. A portion of that premium goes towards your cash value account.

Depending on the type of permanent policy you have, you build cash value based on interest rates, dividends, and investment gains. Policyholders can access their cash value through loans, withdrawals, or by surrendering or canceling their policy.  

Term life insurance vs. permanent life insurance 

Like permanent life insurance, term life insurance offers a death benefit. However, there's no cash value component and your policy will expire after a specified amount of time, usually between 10 to 30 years. Hence, term life is significantly more affordable than permanent life.

The difference between term life insurance and permanent life insurance is similar to the difference between renting an apartment and owning a home. When you rent, you have a lease for a certain term. When that lease is over, you can renew, but most likely with a rent increase. 

Likewise, term insurance lasts temporarily. When your coverage is up, you can reapply. However, your premiums will likely increase as you age and your health deteriorates.

Whole life insurance

Whole life insurance is a lifelong or permanent policy in which you pay a fixed premium for a guaranteed death benefit and guaranteed cash value growth. The insurance company saves a portion of your premium in its own portfolio to increase your policy's cash value. Since whole life insurance offers many guarantees, it's one of the costlier life insurance policies.

Universal life insurance

Universal life insurance allows more flexibility than a whole life policy and grows cash value based on current interest rates. You can raise or lower your death benefit, which increases or decreases your premiums based on your financial situation and needs. For example, if you find that you need less coverage because your children are grown up and your mortgage is almost paid off, you can lower your death benefit. As a result, this decreases your premiums. 

Indexed universal life insurance

Indexed universal life (IUL) , is a type of universal life insurance. So, it offers flexible premiums and coverage amounts. Unlike a universal policy, indexed universal life insurance's cash value invests your premiums in indexed stock markets and bonds based on the S&P 500 and the NASDAQ.

Variable life insurance

Variable life (VL) insurance policy , a type of permanent life insurance, was created years after universal life for people who didn't like how whole and universal life commingled their investments with the insurance company. 

This policy invests your money in subaccounts that track underlying mutual funds, bonds, and stocks. If the market does well, so do you. If the market falls, so does your cash value, making it riskier than whole and universal life.

Tax-deferred growth

Your cash value grows on a tax-deferred basis, meaning you won't have to pay taxes on your earnings until withdrawal. Alternatively, you can decide to pass down your cash value to your beneficiaries . They usually don't have to pay taxes on the inherited amount, except in unique scenarios.  

Option to borrow against the policy

Policyholders can take loans against their cash value. Unlike traditional loans, you can borrow from your policy without undergoing a credit check. Plus, policy loans generally come with lower interest rates and more favorable repayment plans. Be aware that loans reduce your death benefit if not repaid with interest.

Living benefits

Term life insurance only offers a death benefit, which your beneficiaries can access after you're gone. Permanent life insurance allows you to access your cash value benefit while you're alive. You can use your cash value for emergencies, retirement, or other financial goals. 

Considerations before choosing cash value life insurance

Higher premiums.

The cost of permanent life insurance is exponentially more expensive than a term life policy. According to Policygenius, the average monthly cost of a $500,000 term life policy for a male and female with a few health issues is $26. While the average monthly cost of a $500,000 permanent life policy of a male and female in good health is $451.

It's important to only get coverage you can afford. Before purchasing a permanent policy, consider whether the additional cost fits in your budget. 

Potential tax implications

Unpaid loans (which can cause your coverage to lapse) and cash value withdrawals is subject to taxes. You'll have to pay taxes if the withdrawn amount exceeds the amount of premiums paid into your policy. 

There are many ways to use your cash value. You can borrow from your policy via a loan, withdraw from your account, pay your premiums, or use as collateral. It's important to understand how each use impacts your premiums and coverage. 

Your insurer will likely keep your cash value if you pass away before withdrawing it. Your beneficiaries only receive your death benefit. However, you can use your cash value to purchase a paid-up additions rider, which increases your policy's death benefit. 

No, only permanent life insurance policies (whole, universal, indexed universal, variable) offer cash value. Term life insurance doesn't. 

It depends. Compared to the stock market, life insurance policies yield subpar returns. However, if you've maxed out your retirement plan (i.e., 401(k) or Individual Retirement Account (IRA)) for the year, life insurance can be an excellent investing vehicle for its tax advantages.

Find the best life insurance with cash value by comparing costs, coverage options, financial strength, and policy flexibility from multiple insurers. An independent agent can help you compare quotes from different companies and offer personalized advice.

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