There are three major approaches to business valuation: the Income Approach, the Market Approach, and the Cost Approach. Under each of these approaches, several methods might be employed to determine business valuation. We typically use combinations of the three approaches to arrive at a conclusion of “fair value”.
Valuation Approaches and Methods
The income approach involves valuation methods that convert future anticipated economic benefits (e.g., cash flow) into a single present dollar amount. In techniques such as Discounted Cash Flow (DCF) analysis, a discount factor is applied to future benefits to account for the risk or uncertainty of achieving future results. Discount factors are usually derived from industry standard risk premiums for businesses with comparable size, industry, and other characteristics.
Our approach augments basic DCF with a probabilistic approach to estimating future cash flows. We develop ground-up models of future cash flows then systematically adjust the assumptions and inputs of these models to understand the distribution of possible outcomes. The result is a more nuanced understanding of the uncertainties in future cash flows and how they translate into discounting of baseline projections.
The Market Approach involves valuation methods that use market information on comparable businesses to help determine a company’s value. Such methods include the use of valuation multiples derived from guideline public companies or M&A transactions involving comparable private companies. This approach depends on identifying the right subset of companies or transactions and the most relevant valuation multiples and factors that apply to the business to be valued.
We leverage statistical modeling and large databases of public and private data to support our deep experience in market-based valuations. Classification algorithms help us to efficiently identify comparable businesses and transactions, and multiple regression analysis provides insight into which combinations of factors best indicate value.
The Cost Approach, also known as the Asset-based approach, involves methods of determining a company’s value by analyzing the market value of a company’s assets. This valuation approach often serves as a valuation floor since most companies have a higher value as a going concern than they would if liquidated, i.e., the presence value of future cash flows generated by the assets usually far exceed the liquidation value of those assets. “Goodwill” is this difference between the asset value and going concern value.