How does an appraiser value a business? There are three approaches to value a business and the appraiser’s job is to use his education, training, and judgment when calculating the value of the subject business.

The first approach is the Market Approach. With the Market Approach, the appraiser values the subject company by comparing it to other companies that have sold in the marketplace. Some things the appraiser will consider are the size of the business, the profitability, the revenue, and the inventory. The Market Approach is more valuable in industries with a number of comparable business sales.

The second approach is the Income Approach. With this approach, the appraiser looks at the level of risk, liquidity, and size of the investment and the return that is required from other investments of comparable risk, liquidity and investment size to calculate an acceptable rate of return for the investment. Forecasting of earnings and discount rates are among some of the tools used to calculate the business value using this approach.

The third approach is called the Asset Approach (the Replacement Cost Approach). With this approach, the appraiser calculates the current market value of tangible assets such as equipment, inventory, etc. The intangible assets such as goodwill, brand name, etc. are also calculated using acceptable methods that are acknowledged and approved by government agencies, courts, and business appraisal organizations. It is important to know that book value is rarely the same as the current market value of the assets.

The truth about using book value as an appraisal approach is enlightening. The book value of an asset is the original cost minus depreciation. The IRS acknowledges that the acceptable time period for depreciating assets for tax purposes is not equal to the actual life of assets. Most small business use depreciation to their advantage to decrease their tax liability and therefore the book value of the assets are usually lower than the actual fair market value. Book value does not take in to consideration assets that have been fully depreciated but still generate income to the business. The use of book value is not appropriate to find the fair market value of an asset.