Valuation Approaches

The Three Approaches to Business Valuation

Income, market and asset. The framework is constant. What changes is which one leads for your business.

There are three approaches to valuing a business. The income approach values it on the cash it is expected to generate, the market approach on what comparable businesses have sold for, and the asset approach on what its assets are worth less its liabilities. A defensible valuation considers all three and explains the weighting.

The framework

Three approaches, a small number of methods

The Income Approach

What is the present value of the cash this business is expected to generate?

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The Market Approach

What have comparable businesses actually sold for, or what do comparable listed companies trade at?

Read the method

The Asset Approach

What are the assets worth, less the liabilities, if each were restated to market value?

Read the method
Reconciliation

How the three are reconciled into one conclusion

The results of each method applied are set out side by side as a low and a high. The valuer then explains the weighting in words: which approach best reflects how a buyer would actually think about this business, which were used as cross-checks, and which were not applied at all and why, whether that is an absence of reliable comparables or a business that simply is not asset-driven.

The conclusion is an enterprise value range. Interest-bearing debt is deducted, surplus assets and liabilities are added or subtracted, and the result is equity value for 100 per cent on a controlling, marketable basis. Discounts for lack of control or lack of marketability are then applied where the interest being valued calls for them.

That reconciliation narrative is a large part of what makes the opinion defensible, and it is the section another expert reads first.

How much of it appears in your report depends on the depth you need. An Indicative valuation is for internal decision-making and is not written for third party reliance. A Summary report sets out the approaches applied and the reasoning behind them, and a Detailed report applies and reconciles all relevant approaches in full.

Indicative

For internal decision-making. Useful for testing an offer, setting an expectation before a negotiation, or deciding whether to go to market. It is not written for third party reliance.

Summary

Sets out the approaches applied, the normalisation adjustments made and the reasoning behind the conclusion. The usual choice for a sale, an ownership change or a finance application.

Detailed

Applies and reconciles all relevant approaches in full. The level required where a court, the ATO, a lender or another expert will review the opinion.

Questions

Approach questions answered

The three approaches are income, market and asset. The income approach values a business on the cash it is expected to generate, the market approach on what comparable businesses have sold for, and the asset approach on what its assets are worth less its liabilities.
None of them is inherently more accurate. The right approach is the one that best reflects how a buyer would actually think about that particular business, which is why a defensible valuation considers all three, applies the ones that fit and explains why the others carried little or no weight.
All three are considered in every engagement, but they are not all applied in every engagement. A detailed report applies and reconciles every relevant approach and explains the weighting. Where an approach is not applied, for example because there are no reliable comparables, the report says so and gives the reason.
Normalisation is the process of adjusting reported figures to what a hypothetical owner would actually see. Owner remuneration is reset to a market rate, related-party rent and management fees are restated to arm's length, one-off items are removed, and non-operating assets are taken out and valued separately. It is the most common source of disagreement in a valuation, so a defensible report sets every adjustment out in full.
Enterprise value is the value of the business operations to all capital providers. Equity value is what is left for the owners after interest-bearing debt is deducted and surplus assets and liabilities are added or subtracted. A valuation conclusion reaches enterprise value first, then makes that bridge, then applies any discounts for lack of control or lack of marketability.
It follows the economics of the business rather than the industry label. Businesses with reliable recurring earnings are usually led by the income approach, sectors with an active and observable sale market by the market approach, and plant-heavy or thin-margin operators by the asset approach. Each Sydney industry page states which one leads and why.
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