Whenever we talk about approaches of valuation, it means a set of assumptions and rules that will be used with an objective of performing the valuation of the business or organization. Whereas whenever we say methods of valuation it means the process and procedures that helps a valuer to perform the valuation. It can be rightly said that under each and every approach there are various methods of valuation but under the methods there cannot be numerable number of approaches. Valuation can be done for various purposes depending upon its nature and kind. There are different kind of valuations such as business valuation, valuation of Immovable property, stock valuation, valuation of shares, valuation of assets etc.
Approaches of Valuation:
For the valuation process there are three different types of approaches namely;
- Income approach- As we know that for any economic activity of the business, income is the utmost important factor. Any business is carried out for the purpose of generating profits and income. Therefore under this approach of valuation the value of the business or the assets of the company are estimated on the basis of the potential income it can earn in future.
- Market approach- This method is purely based on the market value of the considered assets of the company. The value is derived from a similar asset’s value.
- Cost approach- This approach is also known as the Asset Approach of Valuation. The value of the business under his approach is calculated as the total value of its assets minus the total liabilities.
Methods of Valuation:
Every approach named above has further methods under them which are used to carry on the valuation procedures and various tasks involved in them. These methods are-
- Income Approach: Under the income approach the following methods of valuation are used-
- Capitalization method: The capitalization method of income approach of calculates the present net value of the future cash flow or earnings of the business.
- Discounted Cash Flow Method: One of the methods of valuation that is used to calculate or estimate the absolute value of a company or entity. Here the free cash flow projections in the future and discounts on them are used to arrive at the present value estimation for evaluating the investment potential. In DCF valuation, the following are to be estimated:
- Life of the asset
- Cash flows during the life of the asset
- Salvage value or the terminal value of the asset
- Discount rate to apply in the cash flows to get present value:
The discount rate can be calculated in many different ways-
- Capital Asset Pricing Model
- Internal rate of return (IRR)
- Weighted average cost of capital (WACC) method
Variations of DCF:
- Adjusted Present Value (APV) method
- Free cash flow (FCF)
- Net Present Value (NPV)
- Market Approach: There are two methods of valuation under this approach-
- Comparable transactions method: Under this method, the value of the business is determined on the basis of different derived multiples from valuations of other similar transactions done in the industry.
- Comparable companies’ method: Under this method worth of a business is calculated on the basis of its comparison with other similar businesses having same size or same industry type.
It is influenced by the following multiples or the market conditions that are temporary-
- Price-Earnings multiple
- Market Price to Book value multiple
- Price to Revenue multiple
- Enterprise value multiple
- Cost Approach: Following methods of valuation service are used under this approach-
- Adjusted Net Asset Value: The adjusted net asset value method is one of the methods of valuation for estimating the worth of the business.
- Book Value: The Book Value is the total worth of the assets minus the total worth of the liabilities or what we say the net worth of the overall business.
- Replacement Cost: It takes into account the cost of replacement of the asset.