Business Valuation Approaches: Income, Market, and Asset-Based Methods

✦ Business valuation determines the economic worth of a company for M&A, capital raising, litigation, financial reporting, or strategic planning.

✦ The three primary valuation approaches are income-based (discounted cash flow), market-based (comparables), and asset-based (net asset value).

✦ Selecting the appropriate method depends on the company's industry, stage, cash flow visibility, and purpose of valuation.

✦ Accurate valuation requires reliable financial projections, market data, asset records, and a clear understanding of risk-adjusted returns.

We’ll explore the core valuation methods, their assumptions, advantages, limitations, and when to apply each in a corporate finance context.

1. Income Approach — Discounted Cash Flow (DCF)

The income approach estimates value based on the present value of expected future cash flows.

✦ Most widely used for operating businesses with forecastable free cash flows.

✦ Steps: 

• Project free cash flow (FCFF or FCFE) over 5–10 years 

• Determine terminal value using perpetuity growth or exit multiple 

• Discount all cash flows to present using WACC or cost of equity

Formula:

Enterprise value = ∑ (FCF ÷ (1 + WACC)^t) + Terminal value ÷ (1 + WACC)^n

✦ Terminal value often comprises 60–80 % of total DCF valuation.

Advantages

• Tailored to business-specific performance and risk

• Reflects growth, margin, reinvestment, and capital structure

Limitations

• Highly sensitive to assumptions

• Requires credible forecasts and discount rate selection

• Not suitable for early-stage or highly volatile firms

2. Market Approach — Comparables and Precedents

This approach values a business based on market multiples of similar companies or deals.

✦ Two methods: 

• Public trading comparables (e.g., EV/EBITDA, P/E) 

• Precedent transactions (acquisition multiples from M&A deals)

Steps:

• Select peer group (industry, size, margin profile)

• Normalize financials (non-recurring items, lease adjustments)

• Apply median or weighted average multiples to subject company metrics

Example:

• Median EV/EBITDA of peers = 8.5×

• Company EBITDA = $40 million

• Enterprise value = 8.5 × $40m = $340 million

Advantages

• Market-based and easy to understand

• Reflects investor sentiment and deal environment

Limitations

• Peer comparability challenges

• Market conditions may distort valuations

• Private firms may lack public benchmarks

3. Asset-Based Approach

This method values a business based on the net fair value of its assets minus liabilities.

✦ Often used for asset-heavy or non-operating entities (e.g., real estate, investment holdings, liquidation cases).

✦ Approaches include: 

• Book value (from balance sheet) 

• Adjusted net asset value (restate assets to market value) 

• Liquidation value (value if sold piecemeal in distress)

Example:

• Assets: $120 million

• Liabilities: $80 million

• Adjusted NAV = $120m – $80m = $40 million

Advantages

• Clear floor value in liquidation or distressed scenarios

• Less sensitive to market or forecast assumptions

Limitations

• Ignores future earnings potential

• Difficult to value intangibles (e.g., goodwill, brand)

• Not relevant for high-growth, cash-generating firms

4. Selecting the Right Approach

✦ DCF: 

• Preferred for mature, cash-flowing businesses 

• Used in fairness opinions, strategic planning, impairment testing

✦ Market comparables: 

• Suitable when there are active peers or deal comps 

• Common in sell-side and investor pitchbooks

✦ Asset-based: 

• Used for holding companies, distressed valuations, financial reporting

✦ Often, multiple approaches are used together to triangulate value and perform cross-checks.

5. Reconciliation and Final Valuation Range

✦ Present valuation range based on methods and sensitivity analysis: 

• DCF range 

• Market multiple range 

• Floor value from assets (if relevant)

✦ Adjust for: 

• Control premiums (for full buyouts) 

• Minority discounts (for partial interests) 

• Illiquidity discounts (for non-marketable shares) 

• Synergies (in M&A context)

Example Summary Table

Method	Value Estimate
DCF	$320–$360 million
Trading Comps	$310–$340 million
Precedent Deals	$330–$370 million
Asset-Based (NAV)	$250 million

✦ Final opinion depends on purpose—e.g., fair value for audit, bid price for M&A, or internal strategic use.

6. Governance and Best Practices

✦ Document all assumptions, sources, and methodologies.

✦ Use third-party valuation providers for regulatory or dispute purposes.

✦ Ensure internal controls for model accuracy, consistency, and updates.

✦ Communicate valuation drivers clearly to stakeholders, boards, or investors.