What is a business valuation model?

What is a business valuation model?

A business valuation model is the process by which the economic value of a business or an asset is determined. There are different types of valuation models and each model has its own focus and is supported by a particular set of assumptions. Some of the more popular business valuation models include the discounted cash flow (DCF) model, the Capitalized Excess Earnings model, market business valuation and asset accumulation valuation model. Some models are more appropriate for certain types of businesses than for others.

The Discounted Cash Flow (DCF) valuation method is suitable for young businesses, investment projects and established companies. With this model, the estimated future cash flows of the business are discounted to produce a projected valuation.

The Capitalized Excess Earnings Model is a more appropriate valuation method for well-established business that may have created a significant track record of excess earnings. In this model, the excess earnings over the business’ cost of capital are discounted to its present value and added to the net tangible value of the business assets.

With the Market Valuation method, the value of an asset or company is determined by the selling price of similar assets on the open market by using a comparable valuation multiples, preferably cash flow related or industry specific such as e.g. Enterprise Value / EBITDA or Value Per Room for e.g. a Hotel valuation. This valuation valuation is suitable for businesses in industries where comparable companies are traded on a stock market or that have active markets in which assets are sold on a regular basis.

The Net Asset Value Model is another valuation method for businesses that are asset-rich such as manufacturing companies, or real estate firms. It is the difference between the current value (or eventually liquidation value) of all business assets and the current value of all associated liabilities.

Another method is the replacement cost method, estimating the required cost it would take to reproduce an asset such as e.g. a factory building.

In order to get an accurate business valuation, it is important to compare the results of the different business valuation methods. Since each method produces different results, a triangulation process is being used to determine where the most likely value of the business should lie within.