Business valuation methods: a practical comparison between approaches

Understanding business valuation methods is a key step to determining the real value of a company, especially in strategic contexts such as merger and acquisition deals, the entry of new investors or generational handovers. Business valuation is not based on a single criterion but on a combination of financial models that make it possible to estimate the value of the company from different perspectives. Among the main business valuation methods we find the asset-based method, the income-based valuation method, the discounted cash flow method and the market multiples method. Each of these approaches has advantages and limits and may be more or less suitable depending on the type of business, the reference sector and the objectives of the analysis. For entrepreneurs and investors who want to understand how to value a company, it is important to know the characteristics of each method and to know in which situations to use it. In the case of SMEs, it is often necessary to integrate several analysis tools to obtain a balanced and realistic business valuation. In this guide we will analyse in detail the main business valuation methods, comparing them with each other through concrete examples. Within the article you will also find a practical business valuation example that shows how the different methods can lead to different results when applied to the same company. The goal is to provide a clear and operational overview useful to entrepreneurs, financial advisors and investors who want to better understand how to value a company and choose the most suitable approach according to the context.

Why there are different business valuation methods

Business valuation is a complex process because the value of a company depends on many variables: economic results, assets, ability to generate income and growth prospects. For this reason, several business valuation methods have been developed over time, each able to analyse the company from a specific perspective. The main business valuation methods focus on three fundamental dimensions:

• asset value of the company
• ability to generate income
• market value compared with comparable companies

Understanding how to value a company therefore means knowing how to integrate these different approaches to obtain a more accurate estimate. The main business valuation methods Finance professionals use different business valuation methods to estimate the value of a company. Among the most widespread we find the asset-based method, the income-based valuation method, the cash flow method and the multiples method. Let's look at them in detail.  

Asset-based method

The asset-based method is one of the most traditional among the business valuation methods. In this case, the value of the company is calculated based on the net assets. The business valuation is carried out considering:

• real estate
• machinery and plants
• equity interests
• liquidity
• debts and liabilities

The value of the company is given by the difference between assets and liabilities.

Advantages of the asset-based method

Among the main advantages we find:

• simplicity of application
• strong objectivity of the data used
• usefulness for companies with significant assets

Limits of the asset-based method

The main limit is that it does not fully consider the company's ability to generate future income. For this reason, in professional practice, it is often combined with other business valuation methods.  

Income-based method

The income-based method for business valuation is based on the company's ability to generate profits over time. According to this approach, the business value derives from the capitalisation of expected future income. To apply the income-based valuation method, several indicators are analysed:

• historical profits
• operating margins
• stability of results
• growth prospects

This method is particularly suitable for established companies with relatively stable income flows. The income-based method is widely used in professional practice because it makes it possible to link the value of the company to its ability to produce economic results over time.

Discounted cash flow method (DCF)

Among the main business valuation methods we also find the discounted cash flow method, known as DCF. This method assesses the company based on the future cash flows that it will be able to generate. The business valuation process using the DCF method involves:

1. forecasting future cash flows
2. defining the discount rate
3. discounting cash flows
4. estimating the terminal value of the company

Among the business valuation methods, the DCF is considered one of the most accurate because it takes into account the company's ability to generate value over the long term.  

Market multiples method

The multiples method is one of the most-used in M&A deals and represents one of the most widespread business valuation methods. This approach compares the company with other similar companies on the market. The most-used multiples are:

• EV/EBITDA
• EV/EBIT
• Price/Earnings (P/E)
• EV/Revenues

Applying these multiples to the company's economic results makes it possible to obtain a business valuation based on market benchmarks.  

Comparison between business valuation methods

Each method offers a different perspective on the value of the company. For this reason, it is useful to compare the main business valuation methods. Asset-based method Based on the company's assets and suitable for companies with significant assets. Income-based method The income-based valuation method considers the company's ability to generate income. DCF method Analyses future cash flows and the financial value over time. Multiples method Compares the company with the market and with similar deals. To truly understand how to value a company, it is often necessary to combine multiple business valuation methods.  

Business valuation: case study

To better understand the differences between the various business valuation methods, let's look at a practical example applied to an SME. Let's imagine a company with the following data:

• turnover: 6 million euros
• EBITDA: 1 million euros
• net profit: 600,000 euros

Multiples method If the average sector EV/EBITDA multiple is 5: Enterprise value = 1,000,000 × 5 = 5,000,000 euros Income-based method Applying the income-based valuation method with a capitalisation of profits: Enterprise value = 600,000 / 0.12 = approximately 5,000,000 euros Asset-based method If the company's adjusted net assets are 4 million euros: Enterprise value = 4,000,000 euros This practical business valuation example demonstrates how the different business valuation methods can lead to different results. For this reason, in professional practice, advisors combine different approaches to obtain a more balanced estimate. How to choose the most suitable valuation method Understanding how to value a company also means knowing which method to use based on the characteristics of the company. Some useful criteria in the choice are:

• company size
• sector of activity
• stability of revenues
• presence of significant asset-based items
• purpose of the valuation

In most cases, the most reliable business valuation derives from the combined use of different business valuation methods.  

The role of advisors in business valuation

M&A deals require specific financial and strategic skills. Advisors support companies in the various phases of the business valuation process, including:

• analysis of financial data
• application of the different business valuation methods
• comparison with market benchmarks
• support in negotiations

Thanks to their experience, advisors help entrepreneurs and investors understand how to value a company in a professional way and maximise the value of the deal.   Valuation is a complex process that requires the use of several analysis tools. The main business valuation methods — asset-based, income-based, cash flow and market multiples — make it possible to analyse the value of the company from different perspectives. Through the comparison between these business valuation methods, entrepreneurs and investors can obtain a more realistic and reliable estimate of the business value. The case study example demonstrates how the application of the different methods can lead to different results, making an integrated approach essential. For this reason, understanding how to value a company correctly is a fundamental step in successfully tackling growth, sale or acquisition deals.