Most business valuations are based on four standard methods: asset-based, earning value-based, market value-based, and ROI-based.
An asset-based business valuation values your business based on what it owns. Equipment, real estate, website URLs – anything you could sell is an asset.
Value based on asset accumulation
The asset accumulation approach subtracts your liabilities (what you owe) from your assets (what you own). The amount left over is your asset-based value.
This is also known as the liquidation approach. It figures what the net value would be if the business sold off everything it owned and paid off all its debts.
Value based on capitalized excess earnings
The excess earnings approach takes into account your business’s intangible value.
Tangible assets are physical things like real estate, equipment, and inventory. Intangible assets can’t be held in your hand. They include things like your business’s reputation, intellectual property, and brand recognition.
The second standard method of business valuation assumes a business’s true value is its potential for future earnings. Instead of tallying up what you own today, it looks at what you could be expected to earn tomorrow.
Valuing a business based on past earnings
The past-earnings approach estimates cash flow based on past revenue. This tells you the rate of return and level of risk the average buyer could expect from this business.
Valuing a business based on future earnings
Instead of looking at historical revenue data, the future-earnings approach estimates potential revenue. It uses market trends to calculate what the business will be worth in the future.
The first two standard methods of business valuation are focused inside the company. The third method turns that gaze outward.
A market value approach compares the business to similar businesses that have recently sold. It estimates the business value based on market demand.
As a standalone method, this can be tricky. There have to be enough similar businesses on the market to get a solid estimate. It’s usually combined with another valuation method.
Return on investment is a quick, easy way to calculate the rough value of a business. This is a great starting point to kick off a conversation between a buyer and a seller. It should not be used when it comes to setting an actual asking price, though.
Return on investment is calculated by dividing the dollar amount offered by the percent share of the business.
If you offer $500,000 for a 50% share in a business, you are valuing the business at $1 million.
ROI valuations are quick and dirty – which is why they shouldn’t be used to make a formal offer. Without the level of data the other valuation methods use, you have no idea if you are over- or undervaluing the business.