Methodologies

Book Value: Book value represents the fair market value of the assets minus liabilities. This method is suitable when goodwill is limited or may disappear quickly. This method does not take into account the earnings capacity of the business.

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Discounted Earnings: Projected future earnings are forecasted and then discounted using a rate which reflects the expected rate of return from another investment opportunity with a comparable level of risk. The sum of the discounted future earnings is the current valuation.

This is the most common form of business valuation. The discounted cash flow technique is most often used for valuing service oriented businesses (whose asset bases are often small) and for companies experiencing high growth rates.

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Capitalization of Earnings: This method calculates the amount of capital that would have to be invested at a specified rate to yield the current average net annual earnings of the business. Unlike the discounted earnings method, capitalization considers historical earnings rather than forecasted earnings. This method does not take into account the book value of the business and is generally suitable for service oriented business within limited capital.

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Capitalization of Earnings + Book Value: This method goes a step further than the capitalization of earnings method by attributing some of the earnings to the business’s assets (book value) and the remaining earnings are capitalized at a rate consistent with the risk associated with the business. The capitalized earnings are then added to the book value.

This method might be used when capital is important to income production.