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A valuation approach is one of several common and widely accepted methods of determining the value of an investment. It is most often used in small business, but can also be used for stocks. The three most common types of valuation approaches are income approach, asset approach and market valuation approach. Business owners and investors usually have to deal with valuation during end-of-year assessments or if the business is up for sale.
In general, a valuation approach uses a combination of several methods to reach a final amount. This approach is most often used when businesses are up for sale. A valuation can be conducted by the owner of a business or the prospective buyer or investor. Though business valuation is essential when a business is about to be sold, doing regular valuations can help a business assess its success and its place among other businesses like it.
A system that focuses on a company's money making potential, the income valuation approach relies on the ability of a business to turn a profit to pinpoint its overall value. This valuation approach uses many different methods, all based on income, to determine the value of a business. Common income approach methods for valuators include the cash flow method and the residual income method.
The asset approach determines overall value based on the assets the business or organization owns. Assets can include buildings, equipment or intellectual property that raises the value of a business. Examples of intellectual property might be patents of inventions and designs that the company uses to conduct business, while business equipment can be computer equipment, vehicles and machinery.
In addition to valuation by income and assets, businesses can also undergo a market valuation. This approach determines the value of a business based on the sales amount of similar businesses. Market valuation draws upon sales data gathered in the past.
Business valuations are not absolute. A company that is nearly valueless according to one type of valuation approach may have a high value if a different method is used. For example, a technology company that is making little profit when examined by its cash flow may appear considerably more valuable when the worth of technological patents the company owns is taken into account.
Values are flexible depending on the methods used to reach them and the choices made by the valuator. In addition to the different valuation methods used, sometimes the valuator's personal biases might play a part in how a company is assessed. Still, in most cases, hiring a valuation professional is preferable to an owner performing his own business evaluation. In addition to the valuator's greater knowledge of the methods, an owner is generally not able to look at his own business as objectively as an outside party.