Assets, whether tangible or financial, have inherent value. Understanding this value is essential for successful investing and asset management. It is necessary not only to understand what value is, but also to identify its sources. Every asset can be valued, but the process and complexity of valuation vary depending on the case. Some assets are easier to value than others, and the details of the valuation process may differ. Additionally, it is important to recognize that every valuation involves a certain degree of uncertainty. In this context, company valuation methods form the foundation for understanding and selecting the appropriate approach, depending on the type of business and the purpose of the valuation.
Various approaches have been developed for company valuation. For instance, each approach encompasses several valuation methods that differ in their level of detail. The main objective of a valuer is to select the most appropriate method under given circumstances. However, it is important to emphasize that no method is universal, and each valuation requires a tailored approach.
Value and price are presented as two distinct concepts; therefore, they highlight an important distinction in company valuation methods. Moreover, company valuation professionals typically rely on three main approaches, defined by international valuation standards. All three approaches, in turn, are based on economic principles of price equilibrium and expected benefits. Company valuation methods are defined and aligned with the standards set by the International Valuation Standards Council (IVSC). As a result, those standards are ensuring a professional framework and the reliability of the valuation process.
Three main company valuation approaches
The three primary approaches to company valuation are:
- Market Approach – Valuing a company based on comparison with similar companies involved in market transactions.
- Asset-Based Approach – Valuing a company based on the value of its assets, taking into account all elements of the balance sheet.
- Income Approach – Valuing a company based on expected future earnings, most commonly through discounted cash flow or capitalization methods.
Market Approach to Company Valuation
The market approach involves comparing the value of the company that valuers are appraising with other comparable companies (including their real estate and capital) that buyers and sellers have traded in open market transactions. In most cases, valuers use data from entire company transactions, share sales in similar companies, or prices from past transactions where the same company was involved.
Two methods have evolved within the market approach:
- Comparable Company Transactions Method
- Publicly Traded Comparable Companies Method
When all relevant data on comparable companies are available, the market approach provides high-quality benchmarks. Selecting the right comparable companies is crucial—they should operate in the same industry or in sectors with similar economic indicators. Comparisons must be based on key data and should not be misleading. After selecting the comparables, valuers analyze both qualitative and quantitative factors and differences to estimate the subject company’s value.
Asset-Based Approach to Company Valuation
The asset-based approach can resemble the cost-based method used for valuing various assets (movable assets, machinery, equipment, real estate, etc.). The principle of substitution characterizes the cost-based method, meaning a buyer is willing to pay no more than the cost of replacing all components of the asset.
Two methods used under the asset-based approach include:
- Adjusted Book Value Method, commonly used for financially distressed companies and companies undergoing liquidation.
- Excess Earnings Method, primarily applied in the United States to value smaller family-owned businesses.
Income Approach to Company Valuation
The income approach includes two main methods. The first is the Discounted Cash Flow (DCF) Method, widely regarded in both theory and practice as one of the most reliable and appropriate methods for valuing companies. This method takes into account all key factors: time, risk, and cash flow. Due to its complexity, DCF requires a deep understanding of all aspects of company analysis. As a result, business professionals most frequently use this valuation method in practice.
The second method is the Capitalization Method, a simplified version of DCF. This method forecasts annual returns and uses a normalized annual return, which analysts expect to grow or decline indefinitely at an estimated average rate.
Why the right valuation method is key to a successful transaction
Choosing the appropriate valuation method plays a crucial role in making sound business decisions—whether related to the purchase, sale, merger, or restructuring of a company. Each approach—market, asset-based, or income—has its advantages and is suitable depending on the specific context and goals of the analysis.
This is why experienced professionals should be the ones who handle the company valuation process and objectively assess all relevant aspects of the business. At Unija ETL Consulting, through our specialized company purchase and sale services, we provide comprehensive support—from financial analysis and selection of the appropriate valuation method to guidance during negotiations and finalizing the transaction.
Our goal is to provide accurate and reliable grounds for every important business decision.
