& Which One Is Best For Your Business
Image Credit: Fine Art America
There is nothing wrong in being head over heels in love with the creative aspects of your business and procrastinating away any duties that have to do with crunching numbers. On the flip side, it is important to be educated on these aspects of your business if you want to prevent being taken advantage of. So, first things first. And no this isn’t a dumb question - what is a business valuation?
A business valuation is the process and/or the result of determining the economic value/worth of a company. Think of it as a home appraisal but for your business.
Asset-Based Approaches
An asset-based business valuation will add up all the investments in your company and can be done in one of two ways:
A going concern asset-based approach evaluates the company's balance sheet, lists the business's total assets, and subtracts its total liabilities. This is also called book value.
A liquidation asset-based approach determines the liquidation value, or the net cash that would be received if all assets were sold and liabilities paid off.
Earning Value Approaches
The most common approach, the Earning Value method, is based on the idea that a business's value lies in its ability to produce wealth in the future. This is the kind of thing you see on Shark Tank when Mr Wonderful is trying to figure out how much money a pitched brand can make him in the future. Essentially, how much potential, financially, a business has.
Market Value Approach
Market value approaches to business valuation attempt to calculate the value of your business by comparing your company to similar ones that have recently sold. The process is similar to using real estate comps to value a house. This method does not work well for disruptive brands since there needs to be a sufficient number of similar businesses to compare.
Which Approach Is Best for My Business?
Although the earning value approach is the most popular business valuation method, for most businesses, using a combination of business valuation methods is generally the rule of thumb. If you are a business owner, in order to rule out objective bias, you should not be doing your own business valuation anyways. Whatever professional business valuator you hire will be an expert in this field and recommend the best mix of approaches to get you and your business to a fair valuation.