Business Valuation Models
Business valuation models are used to determine the value of a business. If you are thinking of selling your business, presenting an offer to buy a business or can be used in settling a disagreement.
Determining the value of a business involves an analysis of a variety of different variables including the future prospects of the business, historical performance, structure, circumstances surrounding the business, etc. For example, a business that requires specialized knowledge to operate or a business that has closed and is in the process of selling its assets.
Business valuation models involve an analysis of the past revenues and expenses and then projected into the future. The anticipated cash flows are then discounted into current value using an appropriate discount rate. The discount rate consider the cost of capital and a risk premium associated with the projected cash flows. If a business is more riskier than others, a risk premium may be included within the discount rate.
The two most widely used approaches to valuing a business are the Empirical approach and the Investment approach. The Empirical approach determines the Fair Market Value (FMV) based on open market transactions involving similar businesses. The investment approach is most often used in valuing a closely-held business or interest in a business. Under the investment approach, FMV is determined by using different techniques in analyzing the financial statements combined with a risk measurement theory (described above). The investment approach includes two methods of valuing a business: asset basis and income (or cash flow) basis. The asset basis is used for either a going-concern or a liquidation value approach whereas the income/cash flow basis is used only in the going-concern approach.
Regardless of the method applied, the results of the business valuation models should not change as the valuation needs to consider a diverse set of factors to
determine their impact upon the business. These factors should include political and economic as well as the industry in which the company operates. The business valuation models can be quite complex or they can be simple depending on what the goals are.
If you are planning on selling your business at some future date, business valuation models could help you understand what is being measured and help increase its worth.