What is Business Valuation and What is its Purpose?

What is Business Valuation and What is its Purpose?

October 28, 2020 Admin
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Essentially, business valuation is a collaboration of procedures put together to help recognize the economic value of an entity. Whether a business setup needs to be sold, or funding is induced, or even during situations of inheritance, partner exit, etc, determining the economic worth of the entity is imperative. As simple as it may sound, unfortunately, mistakes are made right at this elementary stage of conceiving the meaning. The economic value of a company and the price of the company hold different meanings and should not be confused with one another. The company price ties to the amount that was realized from the sale of the entity, as per prevailing demand and supply rates. The value of a company on the contrary boils down to the maximum amount a potential investor is willing to spend towards investing in the company. An investor may easily be lured to acquire a company if it instigates his interest. For example, it may be of utmost interest for an investor to serve the local community, and a company that passionately engages in such activities might be highly valued by such an investor. He hence may be delighted to bid the highest price in a company since it fulfills his objective of serving the community. Whereas, some investors will find value in investing in a company with a history of incremental profits. Business value has varied perceptions among different people. The complexity surfaces once there is a need to enumerate maximum values generated from the key business areas. This requires precision in finance and accounting, handling technicalities, and most importantly understanding the business model clearly, identifying its value-generating aspects, layout strategies, and market research. Without the foresight and intuition of an expert valuator, it may be hard to extract the highest value from a business entity.

What is Business Valuation and What is its Purpose?

Overview of the various approaches to Business Valuation


Most valuation techniques that exist can be broadly categorized under 3 basic approaches. Based on the assessment objective, any or a mix of these approaches can be used.


  • Market-based approach – In this technique, business valuation is calculated by comparing the values of similar-sized companies that have been sold. This approach fits perfectly in a situation when the businesses are comparable and competitor data is easily accessible. Having said that, this approach does not obviously suit the evaluation of sole proprietorship businesses, since in such cases comparative data is unavailable.
  • Asset-based approach – In this approach, valuation is reached by adding up all the investments of the company. This can be either calculated from the difference in total assets against total liabilities or by estimating the value of liquidation computed after determining the net in-hand cash, post all the assets are sold, and liabilities have been cleared. This asset-based approach is not ideal for evaluating sole proprietorships, in case personal assets can’t be clearly segregated from company assets.
  • Income-based approach – This approach is formulated with the idea that business value lies within its future revenue generation capacity. It points at the elementary question of what shall the return on investment of time, effort, and money in a business look like. The classic feature of this approach is that it permits ascertaining the current company value by analyzing its present risk and cash flow. Since this Income-based approach is alike predictive analysis based on past and present performance, the future is hence not very accurate as predicted. Therefore, uncertainty and risk always surround this approach.

The major takeaway is that pinning down a fair business valuation may be tricky, yet it’s central for negotiating deals. It's ideal to seek assistance from professionals who recognizes the nature of business and help decide the best-suited valuation method/s to adopt to avail the maximum value that may be quoted to a potential investor or buyer. Although the price may instantly not be agreed upon, it at least connects the two parties through a common ground. It’s essential that the historical financial data disclosed for valuation is authentic, accurate, and comprehensible, based on which the business value approximation can be arrived at. A brilliant idea is to test all the approaches and determine business value from all perspectives. Then the average can be noted as fair business value be used for safe trading. On a finishing note, it’s good to note that, no amount of multipliers, math, or market research would be enough if not coupled with the right instincts.

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