Practice Valuations 101, Part 2: Modern Methods & Application

In the second episode of this series, Erich talks about the different methods to consider when looking at your practice valuation:

Asset Approach

The asset approach to business valuation considers the underlying business assets in order to estimate the value of the overall business enterprise. This approach relies upon the economic principle of substitution and seeks to estimate the costs of re-creating a business of equal economic utility, i.e. a business that can produce the same returns for its owners as the subject business. The business valuation methods utilized under the Asset Approach include:

• Capitalized excess earnings method.

Market Approach

Under the Market Approach to business valuation, one consults the marketplace for indications of business value. Most commonly, industry benchmarks are studied to collect comparative evidence that can be used to estimate the value of the subject business. This approach uses the economic principle of competition which seeks to estimate the value of a business in comparison to current industry benchmarks. The business valuation methods under the Market Approach are:

• Comparative transactions method

• Rules of Thumb (Comparative publicly-traded company transaction method)

Income Approach

The Income Approach to business valuation uses the economic principle of expectation to determine the value of a business. To do so, one estimates the future returns the business owners can expect to receive from the subject business. These returns are then matched against the risk associated with receiving them fully and on time. The returns are estimated as either a single value or a stream of income expected to be received by the business owners in the future. The risk is then quantified by means of the so-called capitalization or discount rates. The methods which rely upon a single measure of business earnings are referred to as direct capitalization methods. Those methods that utilize a stream of income are known as the discounting methods. The discounting methods account for the time value of money directly and determine the value of the business enterprise as the present value of the projected income stream. The methods under the Income Approach include:

• Discounted cash flow method

• Multiple of discretionary earnings method

• Capitalized earnings method

Related Calculators

Capitalization of Excess Earnings

Comparative Transactions

Industry Rule of Thumb

Discounted Cash Flow

Multiple of Discretionary Cash Flows

Capitalized Earnings

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