What is a valuation?
A business valuation combines financial analysis with judgement. There's rarely one "right" value; different methods give a range, and the final price depends on negotiation.
Main valuation approaches
Income approach
- Discounted cash flow (DCF): forecast future [free cash flow](/glossary/free-cash-flow) and discount it to today using a rate such as the [WACC](/glossary/weighted-average-cost-of-capital-wacc).
- Capitalisation of earnings: divide sustainable earnings by a capitalisation rate.
Market approach
- Comparable company multiples: for example enterprise value / [EBITDA](/glossary/ebitda), price / earnings or revenue multiples.
- Precedent transactions: prices paid for similar businesses.
Asset approach
- Net asset value: [fair value](/glossary/fair-value) of assets minus liabilities. Common for property and holding companies or businesses being wound up.
Example
A profitable small business has [adjusted EBITDA](/glossary/adjusted-ebitda) of $400,000. Similar businesses have sold for 4x to 5x EBITDA, giving an enterprise value of $1.6 million to $2 million. Subtracting $300,000 of net debt gives an equity value of $1.3 million to $1.7 million.
What drives value
- Growth and profitability
- [Quality of earnings](/glossary/quality-of-earnings) and [recurring revenue](/glossary/recurring-revenue)
- Customer concentration and risk
- Management depth and systems
- Clean, reliable financial records