If you search the words “business valuation methods” on your favorite search engine, you encounter a wide array of approaches—from detailed, formula-driven techniques to quick, back-of-the-envelope estimates. But not all valuation methods are created equal, nor are they all appropriate for every situation.
Some methods are grounded in rigorous financial analysis and are typically applied by credentialed professionals using established valuation standards. Others, like rules of thumb, rely on general industry benchmarks or anecdotal norms. While these shortcuts can sometimes provide a rough directional sense of value, they rarely account for the specific characteristics that make a business unique—such as growth potential, risk profile, or customer concentration, among other characteristics.
If you’re making important business decisions—such as selling, gifting, litigating, or planning for the future—it’s critical to understand the differences between these approaches and why a professionally developed valuation often provides a more accurate, defensible result.
Dangers of a Rule of Thumb Approach
Rules of thumb refer to broad, informal, and often outdated industry guidelines used to estimate a business’s value—typically based on multiples of trailing twelve-month (TTM) revenue and/or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). These methods reflect the assumption that businesses within an industry sell for similar multiples of these metrics. However, this assumption is deeply flawed and can lead to a significantly inaccurate valuation.
The core issue is that rules of thumb fail to reflect the specific strengths, weaknesses, and nuances of an individual business. The appropriate multiple for your company could vary substantially from the industry average depending on a wide range of factors—including the proportion of recurring revenue, margin profile, historical and projected growth, customer concentration, leadership depth, niche market positioning, intellectual property, and recent operational transitions, among others. Even if you attempt to adjust a rule-of-thumb multiple up or down based on perceived strengths or weaknesses, these adjustments are speculative at best. Since rules of thumb lack transparency into their underlying data sources or methodology, any such modifications are inherently arbitrary and unreliable.
Credible Valuation Approaches and Methods Used by Experienced Valuation Professionals
Qualified valuation professionals employ multiple recognized and complementary approaches to determine a business’s value. The three primary categories include:
- Income approaches—Income-based methods value a business based on its ability to generate future economic benefits for its owners. These methods recognize that a company’s intrinsic value lies in its expected future earnings or cash flows. There are two subcategories of income approaches:
- Discounted Cash Flow (DCF) Method: This method projects the business’s expected future cash flows and discounts them back to present value using a rate that reflects both the time value of money and the specific risks associated with the business. It is particularly useful for companies with fluctuating growth trajectories, emerging markets, or changing cost structures.
- Capitalization of Cash Flow Method: A simplified variant of the DCF, this approach applies a single capitalization multiple to a company’s normalized cash flows, under the assumption that the business will maintain relatively stable performance over time.
Income approaches require:
- Normalization of financial statements to remove non-operating items, discretionary owner expenses, and one-time anomalies.
- Defensible projections are grounded in historical performance, market trends, and company-specific developments.
- Market approaches— Market-based methods estimate value by analyzing how similar businesses are priced in the marketplace. When applied correctly, these approaches offer real-world context by referencing actual market behavior. Two methods exist within the market approach category:
- Guideline Public Company Method: This method looks at valuation multiples from publicly traded companies, ideally in the same industry, and adjusts for differences in size, growth, profitability, and risk, among other factors.
- Guideline Transaction Method: This approach analyzes real-world private company sales that are comparable in size and industry, providing insight into actual transaction pricing.
Both methods require:
- Access to reliable data
- Careful selection of truly comparable companies
- Systematic adjustments for differences in scale, operations, customer concentration, and deal terms, etc.
Unlike rules of thumb, professional market approaches rely on verifiable data and rigorous comparative analysis. Asset-based approaches—Asset-based methods estimate value by calculating the net worth of a company’s assets minus its liabilities, typically using the:
- Adjusted Net Asset Value Method: This method updates book values to reflect current market values of assets and liabilities.
This method is most relevant for:
- Capital-intensive businesses
- Asset-holding companies
- Distressed or non-operating entities
For profitable, going-concern operating businesses, asset-based methods are rarely the primary valuation approach, but they may still provide a useful “floor value” or serve as a sanity check.
Why Professional Valuation Matters
A comprehensive, defensible valuation often incorporates multiple methods across these approaches, with professional judgment applied to weigh each method appropriately based on:
- The purpose of the valuation (e.g., sale, litigation, gifting)
- The nature and lifecycle stage of the business
- The availability and reliability of data
Ultimately, a qualified valuation expert delivers far more than a number—they provide context, credibility, and confidence in the result.
If you’d like to find out more about the business valuation process or what methods might be right for your business, reach out to our valuation team below.
