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How Are Businesses Valued?
The valuation of businesses has grown to be both a science and an art. To arrive at a defensible valuation a valuation expert needs to follow the standards and norms that have been developed by experts in the business valuation field. Many well intentioned valuation professionals fail to produce accurate and defensible valuations because they do not possess the knowledge of the "art". The art portion of valuation comes from the forces of the market and the constant changing dynamic of expected rate of returns for given risks.
There are several commonly accepted valuation methodologies, the following are the most common methods: Capitalization of Earnings, Discounted Future Earnings, Adjusted Book Value, Comparable Price, Excess Earnings Capacity. The valuation expert will carefully utilize the appropriate methods and also utilize the the applicable weights to each of the methods to arrive with a accurate and defensible valuation.
Buyers (Investors) of businesses place an extensive weight on the business's ability to generate sufficient earnings, since these earnings allow them to 1) pay themselves a suitable salary, 2) be able to service the debt incurred in the acquisition of the business, and 3) receive a appropriate return on their investment.