Methods of Business Valuation Explained

A business valuation is an estimate of what a company is worth on a specific date, for a specific purpose. Like a home appraisal, the number depends on facts and context, except the “property” is an operating business with customers, contracts, and risk.

Valuations matter when money and accountability are on the line. Owners use them for a sale or exit price, a partner buyout, divorce, estate and gift planning, tax reporting, lending (including SBA loans), and lawsuits where value must be proven, not guessed.

Most valuations start with three broad approaches: income, market, and asset. Then the valuator adjusts for real-world issues like risk, owner-driven expenses, customer concentration, and the quality of the records. This is where business valuation and forensic accounting often intersect, because clean, supportable numbers make the conclusion easier to defend.

The income approach treats a business like a cash-producing engine. The core idea is simple: a company is worth the cash it can generate for its owners, adjusted for risk.

Two common methods show up here:

Discounted Cash Flow (DCF): You project future cash flows (often 3 to 5 years), then discount them back to today using a rate that reflects risk. Higher risk means a higher discount rate, which usually means a lower value.

Capitalization of earnings: This is a “steady-state” method. Instead of forecasting year by year, you assume the business will produce a stable level of earnings (with modest growth), then convert that single earnings stream into value using a cap rate.

Inputs that often matter most include:

Normalized earnings (removing noise and one-time items)

Working capital needs (how much cash the business must keep tied up)

Owner pay and perks (what’s really required to run it)

Expected growth and pricing power

Customer concentration (one big client can raise risk fast)

A quick example: a stable HVAC service company with repeat customers might fit capitalization if earnings are consistent. A fast-growing software firm with changing margins usually needs a DCF because the next few years drive value.

The market approach answers a practical question: what are buyers paying for similar businesses? It relies on pricing evidence from public companies, private transactions, or broker-reported deals.

Two common methods:

Guideline company method: Uses valuation multiples from comparable public companies, then adjusts for differences like size, growth, and risk.

Transaction method: Uses multiples from actual sales of similar private companies. This can be very persuasive, but private deal data may be limited, and the details behind a deal are not always clear.

Multiples depend on the type of business and the data available. You might see:

Revenue multiples (common in some high-growth sectors)

EBITDA multiples (common for mid-sized operating companies)

Seller’s Discretionary Earnings (SDE) multiples (common in owner-operated small businesses)

“Comparable” is harder than it sounds. Two businesses can share an industry but differ in margins, location, contract terms, or one-time events that boosted last year’s profit.

Example: two marketing agencies each have $2 million in revenue. Agency A has 25 percent EBITDA margins and stable clients. Agency B has 8 percent margins and frequent churn. Even with the same revenue, Agency A often commands a stronger multiple because buyers pay for dependable earnings, not just sales volume.

The asset approach focuses on the balance sheet. In plain terms, value equals fair market value of assets minus liabilities, after adjusting both to reflect reality.

Two common methods:

Adjusted Net Asset Value: Revalues major assets and liabilities to market levels, not book levels. This is common for asset-heavy companies or businesses with weak earnings.

Liquidation value: Estimates what would be left if the business shut down and sold assets, often at discounted prices, after paying liabilities and wind-down costs.

This approach often fits:

Asset-heavy companies (equipment-intensive operations)

Early-stage firms with limited earnings history

Holding companies or real estate-heavy structures

Businesses where profits don’t support a strong income approach value

Book value is not the same as market value. Equipment may be worth less (or more) than depreciation schedules suggest. Inventory may not sell at full cost. Accounts receivable may not be fully collectible. Some liabilities don’t show up cleanly, like warranty exposure, pending disputes, or unpaid taxes.

Simple example: a company has assets on the books of $900,000 and liabilities of $500,000, so book equity is $400,000. After revaluation, equipment is really worth $600,000 (not $450,000), and $50,000 of receivables look uncollectible. Adjusted assets become $1,000,000, liabilities stay $500,000, adjusted net value becomes $500,000.

Normalization means cleaning up earnings so they represent ongoing operations. It often includes “add-backs,” but add-backs must be real, reasonable, and supported.

Common examples include:

Personal expenses run through the business (only when clearly documented)

One-time legal fees from a non-recurring event

Unusual repairs tied to a single incident

Start-up costs that won’t repeat at the same level

Owner compensation is a major driver. A valuation may adjust pay to market rates, because a buyer usually expects to hire or retain management at a fair wage.

Aggressive add-backs can backfire. In a sale, a buyer may discount them. In an audit or court setting, unsupported adjustments can damage credibility.

Risk shows up most clearly in the discount rate and in pricing multiples. Small companies often face higher risk because they have fewer customers, less access to capital, and more dependence on a single owner.

Risk and growth factors that can move value meaningfully include:

Customer concentration and contract terms

Key-person risk (if the owner is the business)

Industry cycles and margin pressure

Supplier dependence

Quality of financial reporting and controls

Control also matters. A controlling interest can change strategy, set compensation, and direct distributions. A minority interest often lacks those powers, which can reduce value.

Two terms come up often:

Minority discount: reflects limited control.

Lack-of-marketability discount: reflects how hard it can be to sell a private interest quickly.

For litigation and tax matters, the standard of value and reporting expectations can be strict. That’s another reason business valuation and forensic accounting are often paired when the valuation is likely to be challenged.

A solid valuation starts with clarity on purpose and timing, then moves quickly into evidence. Turning Numbers focuses on valuations that can be explained in plain language and backed by documentation, which is critical when the number will be reviewed by a buyer, lender, insurer, or opposing counsel.

If you suspect fraud, have messy books, or face a dispute, a forensic-ready approach helps you avoid surprises later. It’s also useful when records are incomplete or when the story behind the numbers matters as much as the math.

Bring what a reviewer would ask for first:

3 to 5 years of financial statements and tax returns

Bank statements and general ledger detail (when available)

Accounts receivable and accounts payable aging reports

Customer and vendor lists (and any major contracts)

Owner compensation details and benefits

Debt schedules, loan statements, and guarantees

Leases and key commitments

Capital spending history (equipment, software, build-outs)

Forecasts with written assumptions

Better inputs reduce surprises and shorten timelines.

Some matters need more than a standard valuation model. They need verification, tracing, and clean support for adjustments. Turning Numbers provides professional business valuation consulting that fits disputes and high-stakes decisions, where the work may be reviewed in detail.

Common situations include:

Partner disputes and buyouts

Shareholder oppression claims

Divorce matters with complex income and hidden assets concerns

Fraud allegations and embezzlement risk

Earn-out disagreements after a sale

Damages claims tied to lost profits or business interruption

Forensic work can test revenue recognition, trace transactions, identify hidden liabilities, and validate add-backs so the valuation holds up under pressure.

Business valuation methods usually fall into three buckets: income, market, and asset approaches. The best choice depends on what the business does, how it earns, and why you need the number. After that, the final value often comes down to adjustments, risk, and the strength of the records behind the earnings.

If the stakes are high or the books are unclear, don’t settle for a rough estimate. Call Turning Numbers or fill out the form for a forensic consultation to get a defensible valuation that fits your purpose and stands up to review.