Finance

Business Valuation Methods: Main Approaches and When to Use Each

Amy Richards | | 5 min read

Quick answer: The three main valuation approaches are income-based (DCF), market-based (comparable transactions/multiples), and asset-based. Use DCF for stable cash flows, multiples for quick estimates, and asset-based for asset-heavy businesses.

Income Approach: Discounted Cash Flow (DCF)

The DCF method estimates value as the present value of projected future free cash flows, discounted at the company's weighted average cost of capital (WACC).

Steps:

  • Project free cash flows for 5-10 years
  • Determine the terminal value (Gordon Growth Model or exit multiple)
  • Apply WACC as the discount rate
  • Sum present values to arrive at enterprise value

Best for: Stable, predictable businesses with identifiable cash flows. Less suitable for early-stage or highly cyclical companies.

Market Approach: Comparable Multiples

This approach values a company by comparing it to similar companies that recently sold or are publicly traded. Common multiples:

  • EV/Revenue: 1-10x depending on growth and margin
  • EV/EBITDA: 6-12x for established businesses
  • P/E Ratio: 10-25x for profitable, stable earnings
  • EV/EBIT: For companies with different depreciation profiles

Best for: Quick estimates, companies with similar public peers, transactions in active markets.

Asset Approach

The asset-based approach values a company based on the fair market value of its net assets (assets minus liabilities). Two methods:

  • Book value: Simple but rarely reflects FMV
  • Adjusted net asset value: Assets/liabilities restated to fair market value

Best for: Asset-intensive businesses (real estate, holding companies), companies with negative earnings, liquidation scenarios.

Precedent Transactions

This market-based method uses actual M&A deal multiples for comparable companies. Since it includes a control premium (typically 20-40%), precedent transaction multiples are typically higher than trading multiples.

Which Method to Choose

Most valuation engagements use a combination of methods (a "football field" valuation) and triangulate the results. The weight given to each method depends on the company's characteristics and the purpose of the valuation.

Internal links (related)

Author

Amy is a Certified Public Accountant (CPA), having worked in the accounting industry for 14 years. She is a seasoned finance executive having held various positions both in public accounting and most recently as the Chief Financial Officer of a large manufacturing company based out of Michigan.