RUNNING HEAD: VALUATION APPROCAH PAPER
Valuation Approach Paper
Javier E. Caycedo Medina
School of Business, Liberty University Online
Author Note
Javier E. Caycedo Medina
I have no known conflict of interest to disclose.
Correspondence concerning this article should be addressed to Javier E. Caycedo Medina
Email: kcaycedo@liberty.edu
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Introduction
Recognizing the value of a company, an asset, a property, or even an intangible asset is a
very important factor in today’s society. Many organizations and entities have develop careers to
become professional on how to determine the value of things, and to do so, the appraisal services
industry has developed a three different approaches to valuation to be able to accurately indicate
a value amount of a good. The intention of this document is to portray the meaning, importance
and challenges business valuation, as well as highlight and contrast the different methods used in
the industry that offers these services.
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Valuation Approach Paper
Business valuation is a topic and a practice that has develop multiple points of
controversy throughout its years of existence. According to an article from the Corporate
Financial Institute, business valuation is the “process of determining the present value of a
company or an asset” (2018). However, the main issue when it comes to determine the value of
something is that there is no general standard for an appraiser to follow to be able to value every
single company and every single asset. This is why multiple approaches and standards were
created. According to Financial Valuation, a textbook written by Hitchner, business valuation is
“the act or process of determining the value of a business enterprise or ownership interest
therein” (p19, 2017). This explanation is a more academic definition designed to teach students
about business valuation; however, when it comes to the real practice, there are multiple entities
and professional organizations that have employees specialized on the many concepts that
business valuation incorporates.
Nowadays, many individuals and small business have focused on learning the appraisal
methods that one needs to know when valuation a company. Hitcher says that according to the
AICPA, many of certified public accountants practice business valuation, many in a full-time
professional frequency (p. 1, 2027). However, the knowledge that professional entities hold is
significantly more relevant in contrast to small businesses and entities. Professional valuation
organizations include:
i. American Institute of Certified Public Accountants (AICPA)
ii. American Society of Appraisers (ASA)
iii. The Institute of Business Appraisers (IBA)
iv. National Association of Certified Valuators and Analysis (NACVA)
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It is very important for a person or business to make sure they look for the appraiser with
not only the right knowledge, but also with the correct criteria of standards designed to value the
business or asset needed. A journal written titled Modern Method of Business Valuation says that
“it is actually the opinion of the value prepared by specialized experts, analysts and valuators on
the basis of the collected and properly utilized information about the company considered and
the environment of its operations” (Miciuła, I., Kadłubek, M., & Stępień, P., 2020). In other
words, it is significantly important to select the right entity to perform the valuation because their
opinion is what will determine the value of what is being appraised.
As mentioned above, performing a fair and accurate valuation is very important, as it will
determine the value of what it is being appraised. According to a journal from the Journal of
Business Valuation and Economic Loss Analysis, “the outcome of a valuation that considers both
the target system and decision field of a real subject is the basic objective: the decision value”
(Olbrich, M., Quill, T., & J Rapp, David, 2015). Determining the value something will eventually
lead to determine a decision that, in some cases, will involve capital expenditures or even the
continuation of operations of a business.
There are many reasons one looks for a valuation; every reason will determine the
method to approach the valuation, and the standards that need to be followed. According to a
journal of Probate and Property, “Business valuations are important for other uses, including, but
not limited to, banking, insurance, interfamily transfers, estate taxes, and unexpected events”
(The Importance of Business Valuations, 2009). In other words, the purpose of why someone
looks for a valuation is an important key in how the appraisal will be conducted.
Hitchner mentions many different reasons why a valuation is needed, for example:
Mergers and acquisition (M&A), marital dissolutions, financial reporting, selling of
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property/business, planning, compensations, etc. (p. 2, 2017). The many reasons why individuals
seek an appraisal is very important for the appraiser, since that will most likely determine the
way in which the appraisal will proceed. According to an article called Top 10 Reasons for a
Business Valuation, “Attaching an accurate valuation to a company is a critical part of ongoing
business strategy” (Feilteau, 2017). To be able to have an accurate valuation as an outcome of an
appraisal, it is very important that entities and users understand the different methods that this
practice uses to approach business valuation.
In the next portion of this document, the three different valuation approaches and their
primary advantages and disadvantages will be discussed. The purpose of this section is to
differentiate and bring clarity of what was the purpose behind each different business valuation
approach.
Market approach
This method is most commonly used when a user or organization is seeking to set a price
for the purpose of selling a business, or to document the price of a business or asset for legal
purposes. Hitchner defines the Market approach as a general way to indicate the value of a
business or an asset that will be apprised, by utilizing one or more methods, using similar
business or goods as a point of reference for comparison (p. 22, 2017). In other words, in this
method, an appraiser will compare the company or the asset, and compare to similar other
companies or assets and their value, to give a comparable and fair market value as a result of the
appraisal. One significantly major advantage of using this method is the fact that all the data and
comparable transactions come from public information that anyone can access, and that is
available for the public to see. This means that the data used when using this method will be
objective, and will not be dependent on personal or independent forecasts. On the other hand,
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using public data can raise the uncertainty to start asking if the data is reliable or not, making this
method a lot less flexible than others.
Income approach
This method is most commonly used in the real state world. Hitchner defines the Income
approach as a general way to indicate the value of a business or asset, by converting anticipated
value into a present amount. (p. 21, 2017). In other words, an appraiser will calculate the income
the property will generate in the future to estimate the value of the business or asset. It is
important to calculate the net operating income (NOI) of the property, and to choose a
capitalization rate from the previous market sales from comparable properties. On the biggest
advantages of this method is that the outcome will be very specific to the market that the
property belongs to, since the comparable sales that the appraiser takes as a reference are in some
way similar to the property that is being appraised. However, it is always important to take a look
at the condition of the property because any future necessary repairs will increase the cost, and
will not necessarily increase the value of the property. On the other hand, the major disadvantage
this method faces is that the value given by using this method is fully subjected to the individual
opinion of the appraiser.
Asset (cost) approach
This method is most used when it comes to build or construct a property or building.
Hitchner defines the Asset approach as a general method to indicate the value of a business or
good, by determine the total value of assets net of liabilities (p. 18, 2017). In other words, the
value is determined by the total monetary amount an individual holds, and subtracts the total
monetary amount of short and long term debt and liabilities. The total amount out of this
equation is the value that will be given. When using this method in the building industry, it is
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very important to consider topics like depreciation and improvements. As mentioned previously,
this approach fully focuses on determining a value by evaluating the internal monetary condition
of the company; at any moment, this method uses other companies or entities as a comparable
reference to contrast. Additionally, in this method it is very common to use terms like the
assumption for going-on concern. In better terms, this method assumes that the property will
continue to have normal operations, and will continue to generate cash as part of the future
assets.
As it is evident above, every method was designed to be sued in a different opportunity,
since not all valuations can be all created under the same standards. According to an article form
the Wall Street Journal, “regulators and investors are focusing more attention on how private-
equity firms value the assets they own, making the valuation process both more complicated and
costly” (Cumming, 2019). Creating a valuation will always be complicated since ultimately, all
methods have very strong disadvantages that could potentially put in risk the outcome of the
valuation. When performing an appraisal, there will always be some level of subjective opinion.
This means that the valuation could give the wrong value to a business or to an asset.
Investors should also pay attention to how valuations are performed. A poorly performed
valuation can give the wrong present value of an investment, putting in risk a possible
calculation for a future value of the investment, which will eventually lead an investor to make
the wrong decision. According to an article from the Wall Street Journal “changes in the value of
intangibles can have a big effect on the perceived value of companies for stock investors and
lenders” (Monga 2016). Intangible assets are usually very difficult to assign value to, since there
is not always an accurate comparable asset that could be used as reference. This is why changes
in the value of intangible assets are usually seen as a hazard to investors looking into capitalizing
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from the companies and assets likes this. A very big example of this is how big changes in social
media platforms usually either bring big fortune or cost a lot of money to investors.
Additionally, investors should also pay attention to how private equity funds are not only
valuing their assets, but also on what is the expected value these assets will have and generate
from operations in the future. According to an article from the Wall Street Journal “Investors in
private-equity funds are focusing more intently on how fund managers value their assets as they
brace for further markdowns in their portfolios over the next quarter or two” Singh, 2020). As the
world is currently facing a significant decrease in the overall market due to a major health-
related crisis, investors need to look at what equity funds are reporting, projecting, and using in
their assets, before making a decision. In situations like this, the outcome of an investment is
very unpredictable; however, this is not an excuse to perform a proper and formal valuation to
make sure there is a responsible decision before making an investment.
Conclusion
It is very clear that there is not a general right or wrong method to approach business
valuation. Throughout this document, it was very evident that the accurate selection from the
different approaches will be relevant depending on the company or asset that is going through the
appraising process. It is important to know and always have in mind that what worked for one
valuation will not always work for another, even if the same approach is being used. It is
ultimately up to the professionals to make sure they have trained and equipped employees that
understand the standards of value that apply to each situation in order to select the correct
valuation approach that will lead to the fairest and best value. Even though valuations are not
always right, or it does not indicate the exact price of a business, a professional should always
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strive to an objective and fair valuation, even if the outcome is to indicate what the company is
not worth.
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References
Corporate Finance Institute. (2018, November 19). Valuation.
https://corporatefinanceinstitute.com/resources/knowledge/valuation/valuation/
Cumming, C. (2019, December 23). Tougher Valuation Standards Raise the Bar for Managers
and Investors. WSJ. https://www.wsj.com/articles/tougher-valuation-standards-raisethe-
bar-for-managers-and-investors-11577105136
Feilteau, R. P. (2017, February 9). Top 10 reasons for a business valuation. Gray Gray & Gray.
https://www.gggcpas.com/Top-10-Reasons-for-a-Business-Valuation#:~:text=Minimizes
%20the%20financial%20risks%20in,a%20sale%20of%20their%20business
Hitchner, James R. (2017). Financial Valuation: Application and models (4th Edition). Published
by John Wiley & Sons, Inc., Hoboken, New Jersey.
Miciuła, I., Kadłubek, M., & Stępień, P. (2020). Modern Methods of Business Valuation—Case
Study and New Concepts. Sustainability, 12(7), 2699.
http://dx.doi.org.ezproxy.liberty.edu/10.3390/su12072699
Monga, V. (2016, November 21). Valuation experts will be held to a new standard. WSJ.
https://www.wsj.com/articles/valuation-experts-will-be-held-to-a-new-standard-
1479740400
Olbrich, M., Quill, T., & J Rapp, ,David. (2015). Business Valuation Inspired by the Austrian
School. Journal of Business Valuation and Economic Loss Analysis, 10(1), 1-43.
http://dx.doi.org.ezproxy.liberty.edu/10.1515/jbvela-2014-0001
Singh, P. (2020, May 14). Coronavirus pandemic scrambles private-equity valuations. WSJ.
https://www.wsj.com/articles/coronavirus-pandemic-scrambles-private-equity-valuations-
11589494824
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The Importance of Business Valuations. (2009). Probate and Property, 23(4), 7.
http://ezproxy.liberty.edu/login?qurl=https%3A%2F%2Fwww.proquest.com%2Fdocview
%2F191692352%3Faccountid%3D12085
