The three broad approaches are market, income, and asset.
The three broad approaches are market, income, and asset. A market approach compares the business with sold companies, an income approach converts expected cash flow into value, and an asset approach considers the value of assets less liabilities. The best method depends on the company and purpose.
What matters before using the headline answer
- The market approach relies on comparable transaction evidence, the income approach relies on expected economic benefits and risk, and the asset approach relies on asset and liability values under a stated premise.
- Method choice should follow the company’s economics and available evidence rather than the method that produces the highest answer.
- Numerators and denominators must match: enterprise value, equity value, SDE, EBITDA, revenue, and free cash flow are not interchangeable.
- A method can still be useful when evidence is imperfect, but the result may deserve less weight, a wider range, or a stronger limitation.
Market approach: what comparable buyers paid
A market approach compares the subject company with transactions involving reasonably similar businesses. The analyst studies the earnings measure, size, date, industry, geography, and deal terms behind each multiple.
The strength of this method is its connection to real transactions. Its weakness is that private deal data can be incomplete, self-reported, or not truly comparable. Asking prices are not substitutes for closed sales.
Income approach: what future cash flow supports
An income approach estimates future economic benefits and converts them into present value using a capitalization or discount rate that reflects risk and growth. It is sensitive to assumptions about margins, reinvestment, working capital, and the durability of cash flow.
A discounted cash flow model can be useful when future years differ materially from historical results. For a stable company, a capitalization-of-earnings method may be more concise.
Asset approach: what the operating assets are worth
An asset approach adjusts assets and liabilities to a relevant value basis. It can be important for holding companies, asset-intensive operations, underperforming companies, or liquidation scenarios.
For a profitable service company, asset value alone may miss the value of customer relationships, staff, systems, and goodwill. For a capital-intensive business, ignoring assets and replacement needs can be equally misleading.
Choose the unit of value and financial denominator together
A transaction multiple is coherent only when its numerator and denominator describe the same economics. Enterprise value is commonly compared with an operating measure before interest, while equity value reflects the value remaining to owners after the treatment of debt and other claims. SDE, EBITDA, revenue, and free cash flow are not interchangeable simply because each can appear in a database.
The same discipline applies to asset values. Book value records historical accounting amounts; replacement cost, orderly liquidation value, and fair market value answer different questions. A valuation should identify the basis used for equipment, inventory, receivables, real estate, and intangible assets rather than treating the balance sheet as an automatic market-value schedule.
Use a method-specific evidence checklist
For a market approach, document the transaction date, industry, size, geography, financial measure, deal structure, and whether the observation is a closed sale or an asking price. For an income approach, document the forecast, normalized margins, taxes, working capital, capital expenditures, growth, and discount or capitalization rate. For an asset approach, document condition, obsolescence, liens, productive use, and disposition assumptions.
A method becomes less reliable when its most important inputs cannot be verified. The solution is not always to abandon it; sometimes the conclusion should be a wider range, lower weight, or a clear statement that another method provides the more defensible indication.
Method-selection matrix for closely held companies
The table is a screening tool, not a mechanical decision rule. A reviewer may use more than one approach, but should identify the evidence required and the conditions that weaken each indication.
| Issue | What the owner should assemble | What a buyer or reviewer will test | How it affects the decision |
|---|---|---|---|
| Market approach | Closed transactions with known date, size, industry, earnings definition, included assets, and consideration terms. | Reject asking prices, mismatched operating models, stale observations, and multiples whose numerator or denominator cannot be reconstructed. | Useful when comparable private transactions exist and the subject can be placed within their distribution. |
| Capitalized earnings | Stable normalized cash flow, supportable long-term growth, recurring capital needs, working-capital requirements, and risk support. | Determine whether a single maintainable period reasonably represents the future and whether growth is consistent with reinvestment. | Useful for established companies with relatively stable expected economics. |
| Discounted cash flow | Integrated forecast tied to capacity, price, volume, margin, staffing, taxes, capital expenditures, and working capital. | Compare the forecast with historical accuracy and run sensitivities on the assumptions that create most of the value. | Useful when future periods differ materially and can be forecast with credible operational support. |
| Adjusted net assets | Asset inventory, condition, ownership, liens, appraisals, receivables, inventory quality, liabilities, and disposition assumptions. | Replace book values with the relevant market or liquidation basis and recognize removal, obsolescence, and contingent obligations. | Often important for holding, asset-intensive, underperforming, or liquidation scenarios. |
Test a method before accepting its answer
A method should survive a relevance test, an input-quality test, and an economic-consistency test.
- 01
Identify the economic unit
State whether the calculation produces enterprise value, invested-capital value, equity value, or asset value and list the claims included.
Deliverable: Value-definition note
- 02
Inspect the critical input
For market evidence inspect comparables; for income evidence inspect cash flow and risk; for asset evidence inspect condition, ownership, and valuation basis.
Deliverable: Method evidence checklist
- 03
Recalculate independently
Preserve raw inputs and rebuild the formula without hidden overrides. Reconcile the earnings or asset figures to the company’s source records.
Deliverable: Reproducible method worksheet
- 04
Run a sensitivity range
Change the few inputs that drive the result and show why each case is plausible. Avoid false precision in discount rates or multiple selection.
Deliverable: Base, downside, and upside exhibit
- 05
Reconcile with the business facts
Compare the result with financeability, replacement compensation, asset needs, working capital, and the likely buyer’s return requirements.
Deliverable: Method weighting memorandum
Worked example: method choice changes with the company’s facts
Compare three hypothetical companies that each report $300,000 of accounting profit: a recurring maintenance business, a real-estate holding company, and a young manufacturer completing a large capacity expansion. The same income statement subtotal does not make the same method most informative.
| Company profile | Primary analytical emphasis | Reason |
|---|---|---|
| Stable maintenance company | Market and capitalized earnings | Repeat service, steady normalized cash flow, and relevant small-company transactions may support both approaches |
| Real-estate holding company | Adjusted net assets and property appraisal | Value is concentrated in identifiable property rather than transferable operating goodwill |
| Expanding manufacturer | DCF with market and asset checks | Future capacity and capital spending differ materially from historical results |
| Underperforming asset-heavy operator | Going-concern versus orderly-disposition cases | The decision may depend on whether earnings can be restored or assets are more valuable outside current operations |
Method selection follows the economics. Applying one median earnings multiple to all four cases would ignore asset ownership, capital requirements, growth timing, and the reliability of current earnings.
The reviewer should still consider other approaches and explain why they receive less weight. For example, a DCF forecast without capacity, staffing, and working-capital support may be less reliable than a market indication even when future change is expected.
Where the analysis or preparation usually breaks down
Calling book value an asset valuation
Why it matters: Historical accounting amounts may not reflect condition, obsolescence, liens, market demand, or disposition cost.
Better approach: State the relevant premise and obtain support for material asset and liability values.
Using a DCF to legitimize an unsupported forecast
Why it matters: A detailed spreadsheet can disguise assumptions that are inconsistent with capacity, staffing, or customer evidence.
Better approach: Tie each forecast driver to operating history, signed evidence, or an explicitly labeled scenario.
Mixing enterprise and equity measures
Why it matters: Debt or cash can be counted twice or ignored, and the multiple may compare unlike transaction economics.
Better approach: Label the value level on every calculation and use a separate bridge to equity or proceeds.
What a defensible owner decision looks like
No valuation method is automatically superior. The stronger indication is the one that fits the company, uses traceable inputs, and explains its most important uncertainty.
Owners should ask what economic question the method answers, what evidence drives it, and what fact would cause the result to change. Those questions expose more than a list of formulas.
Questions owners ask
Should I use more than one method?
Often yes, as a reasonableness check. The methods should be reconciled based on relevance and evidence, not simply averaged.
Which method is most common for a small owner-operated business?
A market approach applied to normalized SDE is common for planning, but company-specific facts can require another method.
Can an asset-rich business still be worth less than its equipment?
Yes. Debt, removal costs, weak demand, specialized equipment, environmental obligations, and operating losses can reduce what an owner realizes. The relevant premise and asset condition must be tested.
Must every valuation use all three approaches?
No. A reviewer should consider relevant approaches, but may conclude that a method is not reliable or meaningful for the assignment. The omission or low weighting should be explained.
When is an asset approach a floor?
It is not automatically a floor. Liens, removal costs, specialized equipment, weak demand, environmental exposure, and operating losses can reduce realizable value. The premise and disposition costs matter.
Can a market and income approach use the same earnings figure?
They can begin with the same normalized economic base, but the market multiple and income capitalization assumptions must remain independent and internally consistent.
Sources and review date
Last reviewed: July 26, 2026. Sources are linked for context; a national benchmark is not a substitute for local comparable sales or a purpose-specific appraisal.
- IRS valuation job aid and Revenue Ruling 59-60 — Appendix A reproduces Revenue Ruling 59-60 and its closely held business valuation factors; the job aid itself states that it is not legal authority.
- IRS Instructions for Form 8594 — Explains purchase-price allocation for qualifying asset acquisitions, including inventory, equipment, identifiable intangibles, and goodwill.
- U.S. Small Business Administration: Merge and acquire businesses — Owner-oriented guidance on valuation, agreements, due diligence, and professional support in an acquisition.
- BizBuySell industry valuation benchmarks — Reported Main Street sold-business data. A national category range is context, not a company-specific conclusion.
- SBA SOP 50 10 lender and development company loan programs — Current SBA lending procedures; financing rules can affect valuation scope, equity injection, seller debt, and change-of-ownership underwriting.
- IRS Publication 583: Starting a Business and Keeping Records — Describes recordkeeping and reconciliation practices, including agreement among bank statements, books, and supporting business records.
- U.S. Census Bureau: North American Industry Classification System — Official industry definitions used to separate economically different operating models before selecting comparable data.