Top 5 Business Valuation Methods Explained (With Examples)

Introduction: Why Method Matters

Determining the value of a business is not just about crunching numbers—it’s about using the right valuation method for your specific context. Whether you are selling your company, raising capital, or planning your exit strategy, the method you choose can dramatically influence your valuation. Each approach has its strengths and is tailored for each industry, premise, and financial situation. In this article, I will explore the five most common business valuation methods, with real-world examples and practical insights to help you decide which one fits your needs.

Overview of Valuation Methods

Business valuation methods typically fall into three major categories:

• Asset-Based Approaches – Focus on the net value of the business’s tangible and intangible assets.

• Income-Based Approaches – Centered around the company’s ability to generate future income.

• Market-Based Approaches – Compare the business to similar ones in the market.

Let us dive into each of the top five methods with explanations and examples.

Method 1: Asset Approach – Asset-Based Valuation

What It Is:

This method calculates a company’s value based on the net value of its assets minus its liabilities.

Best For:

• Asset-heavy businesses (manufacturing, real estate)

• Liquidations or distressed sales

• When profitability is inconsistent or in deep decline

How It Works: Total Assets – Total Liabilities = Business Value

Example:

A construction company owns $2 million in equipment and has $500,000 in liabilities.

Valuation: $2,000,000 - $500,000 = $1.5 million

Pros:

• Straightforward

• Good for hard asset-rich companies

Cons:

• Ignores earnings potential

• Can undervalue service or tech businesses with few tangible assets

Method 2: Income Approach – Discounted Cash Flow (DCF)

What It Is:

DCF values a business based on projected future cash flows, discounted to present value using a risk-adjusted rate.

Best For:

• Startups with strong growth potential

• Businesses with predictable cash flow

• Investment-grade companies

How It Works:

Estimate cash flows for 5–10 years → Choose a discount rate (e.g., 10%) → Calculate the present value of those cash flows.

Example:

If a company is projected to earn $500,000 annually for the next 5 years, and the discount rate is 10%, the DCF method might value it at…

Valuation:  $1.9–$2.1 million depending on assumptions.

Pros:

• Reflects future earning potential

• Great for growing businesses

Cons:

• Complex and assumption-heavy

• Sensitive to small input changes

Method 3: Income Approach – Capitalization of Earnings

What It Is:

This method estimates a business’s value by dividing expected earnings by a capitalization rate; usually calculated using a build-up model (reflecting business risk).

Best For:

• Stable, mature businesses

• Companies with consistent earnings

How It Works:

Annual Earnings ÷ Capitalization Rate = Business Value

Example:

A small accounting firm earns $200,000 annually and is considered low risk. Using a 20% cap rate…

Valuation: $200,000 ÷ 0.20 = $1 million

Pros:

• Simpler than DCF

• Suitable for businesses with stable income

Cons:

• Assumes constant earnings

• Picking the wrong cap rate can skew results

Method 4: Market Approach – Revenue Multiple

What It Is:

This method uses recent sales of similar businesses and applies a revenue multiple (e.g., 1.2x revenue).

Best For:

• SaaS or subscription businesses

• High-growth, revenue-driven companies

How It Works:

Revenue × Industry Multiple = Business Value

Example:

A marketing agency with $1 million in annual revenue sells in a market where similar businesses go for 1.2x revenue.

Valuation: $1,000,000 × 1.2 = $1.2 million

Pros:

• Market-driven

• Quick to calculate

Cons:

• Does not account for profitability

• Requires reliable market data

 

Method 5: Market Approach – Seller’s Discretionary Earnings (SDE) Multiple

What It Is:

Popular in small business sales, this method values a business based on its SDE—a measure of earnings adjusted for owner’s salary and benefits.

Best For:

• Small to mid-sized businesses

• Owner-operated companies

How It Works:

SDE × Industry Multiple = Business Value

Example:

A local gym has an SDE of $150,000. Comparable sales suggest a 2.5x multiple.

Valuation: $150,000 × 2.5 = $375,000

Pros:

• Widely used for small businesses

• Reflects true cash flow available to a buyer

Cons:

• SDE adjustments can be subjective

• Relies on accurate, normalized financials

Real-World Examples for Each

Valuation Method	Business Type	Example	Estimated Value
Asset-Based	Auto Repair Shop	$600k in assets, $200k liabilities	$400,000
DCF	Tech Startup	$300k annual cash flow growing 20%	~$1.8 million
Capitalization of Earnings	Law Firm	$250k annual profit, 25% cap rate	$1 million
Revenue Multiple	SaaS Company	$1M revenue, 3x multiple	$3 million
SDE Multiple	Coffee Shop	$100k SDE, 2.5x multiple	$250,000

Which Method Fits Your Business?

Choosing the right valuation method depends on multiple factors:

• Business size & stage: Startups might use DCF, while small businesses lean on SDE.

• Industry: Market comps are easier to find for some industries.

• Asset profile: Asset-based works well for capital-heavy businesses or those being liquidated.

• Income stability: Cap earnings methods work best for consistent profits.

General Guidelines:

Situation	Recommended Method
You are selling a small business	SDE or Market Approach
You are raising capital	DCF or Revenue Multiple
You are liquidating assets	Asset-Based
You run a stable, profitable firm	Capitalization of Earnings
You are in a high-growth industry	DCF or Revenue Multiple