Understanding the worth of a company throughout its life cycle — from inception to growth, and perhaps even until sale — is vital for owners, investors, and stakeholders in today’s dynamic and competitive marketplace. A strong business valuation is a key element for making informed decisions, whether you are getting ready to sell your business, secure a new investor, or explore strategic alternatives. This ultimate guide details nine of the most common valuation methods and explains the key business valuation formula, and provides an easy to follow step by step how to guide on doing your own valuation.
What Is Business Valuation?
Fundamentally, business valuation is the analytic process of assessing the economic all-value of a company. This evaluation takes into account not only tangible assets such as real estate, machinery and inventory, but also intangible aspects, like the reputation of a brand, relationships with customers and intellectual property. Using one or more of these valuation methods, practitioners arrive at an estimated value for various purposes: mergers and acquisitions, tax minimisation, exit planning, and financing discussions.
Why Valuation Methods Matter
Not all valuation methods suit every enterprise and circumstance. You would expect a high-growth technology startup to be valued at a premium on anticipated future earnings, while an asset-heavy manufacturing firm would best be valued based on its book or replacement cost. Selecting the appropriate approach — or combining one or more methods — will guarantee that your valuation mirrors the company’s true economic reality and industry context.
Nine Valuation Methods
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Asset-Based Valuation
The asset-based method counts up all the fair market value of a company’s assets, then subtracts liabilities for net asset value. While this method is particularly relevant for asset-rich firms, it may underweight companies whose true incalculable value lies in avenues like brand equity or proprietary operating processes.
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Book Value Method
When combined with asset-based valuation, we have the book value method, which is based on data available on the balance sheet, i.e. historical costs figures. A very straightforward measure to calculate, book value does not necessarily correlate directly with market value — particularly in the case of companies with large, intangible assets (or where depreciation lines have little to do with economic death).
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Liquidation Value
Liquidation valuation estimates the value that could be obtained by selling a company’s assets off individually. This conservative method is usually employed in bankruptcy cases or distressed sales. Liquidation values are typically much lower than going-concern valuations, and serve as a useful, though not definitive, floor when negotiating price.
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Capitalised Earnings Method
The capitalised earnings method extrapolates a representative level of earnings indefinitely into the future and applies a capitalisation rate (the inverse of a price/earnings multiple) to these projected earnings. Dividing normalised earnings by the capitalisation rate yields a present-value estimate. This method assumes some stability in future earnings, so it’s not as applicable to high-growth or highly cyclical businesses.
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Valuation by Discounted Cash Flow
Perhaps the most well-known of the income-based approaches, discounted cash flow valuation projects free cash flows over a specified forecast period (usually five to 10 years) and discounts them back to present value at an appropriate discount rate (often the company’s weighted average cost of capital). This approach retains both the timing and risk profile of future cash generation, producing a granular, forward-looking estimate of value.
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Comparable Company Analysis
Known as “trading multiples” or “public comps,” this market-based approach involves selecting a peer group of publicly listed companies for which relevant multiples—such as the EV/EBITDA or the price/earnings multiple—are applied to the metrics of the subject company. At the same time, comparable analysis shows current market sentiment but demands careful adjustment for peer runway and profitability differences.
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Precedent Transactions
In a precedent transactions analysis you look for recent M&A transactions in the same industry, and apply the transaction multiples (e.g. purchase price to revenue or EBITDA) to your company. Because these multiples reflect acquisition premiums, this approach typically produces higher values than public-comps analysis. It provides real-world deal context, but it is contingent on identifying truly comparable transactions.
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Price/Earnings Multiple
A price/earnings (P/E) multiple is one of the basic approaches you can use based on market: take the company profits and multiply by a reasonable price/earnings multiple based on peers or historical. Although convenient to calculate, the P/E method ignores balance sheet structure, cashfree flow, and variation in accounting policies, so should be used together with other measures.
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Adjusted Net Asset Method
This hybrid approach begins with the net book value of assets and liabilities, and adds adjustments for fair value (market value) of individual assets. It adds intangibles such as intellectual property, customer contracts, and goodwill, and adjusts liabilities for off-balance sheet obligations. The outcome is a combination of the rigor of asset-based approaches and a more reality-based market perspective.
The Business Valuation Formula Explained
Though each method is derived mathematically, the general business valuation formula for income approaches can be stated as:
Value = ∑ (Cash Flow<sub>t</sub> ÷ (1 + r)<sup>t</sup>) + Terminal Value ÷ (1 + r)<sup>T</sup>
- Cash Flow<sub>t</sub> represents projected free cash flows in year t.
- r is the discount rate or capitalisation rate—often based on the weighted average cost of capital (WACC).
- T denotes the final year of detailed forecasts, after which a terminal value is estimated.
For the terminal value—critical in discounted cash flow valuation—you may apply the Gordon Growth Model:
Terminal Value = Cash Flow<sub>T</sub> × (1 + g) ÷ (r − g)
- g is the perpetual growth rate of cash flows beyond year T.
By substituting these elements into the general formula and summing it across the projection periods, you derive an estimate of present value that takes into account time value of money and growth potential.
How To Calculate Your Own Valuation: A Step-By-Step Approach
Determine the Purpose and Scope: Be clear about why the valuation is needed–sale, investment, financing or tax compliance. The use case may affect the approach to valuation methods and assumptions.
Historical Financials: Obtain at least 3 to 5 years of audited financials. Make accounting policies consistent, and normalise for any one-time or nonrecurring items.
Select Your Valuation Approaches: Pick two to three complementary methods based on industry traits and company particulars. For example, combine discounted cash flow valuation with market comparable and asset-based checks.
For a forecast for the future performance: Make projections for revenues, expenses and capital expenditure detailed. Formulate projections on industry trends, competitive positioning, and management plans.
Estimate Discount and Capitalisation Rates: Use the Capital Asset Pricing Model, or similar approach, to estimate the cost of equity (along with the cost of debt) to arrive at the WACC. Select rates indicating required returns and growth expectations when including capitalisation methods.
Implement the Valuation Formulas: For each method, implement the business valuation formula: discount future cash flows for DCF business valuation, apply multiples for comparable companies or other market based methods, and adjust asset values for asset based approaches.
Perform Sensitivity Analysis: Assess how changes in critical assumptions — growth rates, discount rates, margins — alter value. This reveals the strongest valuation drivers and areas that require strong backing.
Reconcile and Reconcile Values: Compare outputs across different methods. Demerit each result based on a factor of importance and trustworthiness; for instance, weighting’ DCF higher when forecast accuracy is high.
Doc therapeutic assumptions and conclusions: Publishing the valuation report stating all inputs, methodologies, adjustments, and the value conclusion. Such transparency strengthens credibility with stakeholders.
Common Mistakes and Suggestions for Concise Valuation
Overly Optimistic Forecasts: Avoid the forecasting bias of overestimating demand unique to your product area by benchmarking projections against industry growth rates and historical performance.
Incorporating Items That Are Non-Operating: Make sure things like surplus cash, unfunded pension plans, or ongoing lawsuits are included.
Poor Peer Selection: While dealing with market-based methods, select truly comparable companies; adjust for differences in scale, geography and business model.
Underestimating Discount Rate: A minor change in r will substantially affect DCF results. Market data, multiple sources, etc.
Conclusion
Business valuation is an art and science, and mastering both elements. By first understanding the strengths and limitations of each of the nine valuation methods, second applying the core business valuation formula, and third following a careful how-to guide—it is possible to extract credible and defensible value estimates for any business. Prepare for exit as a founder, evaluate potential as an investor, serve as a financial expert advising your clients — a structured, robust valuation process yields strategic insights and is the bedrock for good decision-making.
