There are several approaches you can take to valuing a business, security or intangible asset. These are usually categorised as:
- probabilistic (this approach may be included within other valuation approaches, such as the income approach).
The approach you choose depends on the context and purpose of the valuation and the particular characteristics of the item being valued. Often, you will combine several valuation approaches to reach an opinion on the market value of an item.
When using the market-based approach, you would analyse transactional or trading data based on information typically found in the public domain. This information may include licensing agreements, mergers and acquisitions, capital raisings, divestments and on-market transactions.
The comparable transaction and comparable trading methods are examples of the market-based approach and are often used to derive or assess a market value for securities.
Using the income-based approach, you determine the market value of an item by estimating a set of economic benefits (such as cash flow or earnings) that will be derived from that item for either a finite or perpetual term. This approach often overlays evidentiary factors (such as price or earnings multiples available from the public markets) with more subjective factors (such as estimated earnings). The 'capitalisation of earnings' (often categorised as a market-based method) and 'discounted cash flow' methods are examples of the income-based approach.
The asset-based approach is typically used to derive the market value of a business, usually on a 'going-concern' or liquidation basis. This approach is commonly used (on a going-concern basis) for valuing holding and investment companies.
The cost-based approach can be used to derive market value where market or income factors are difficult to obtain or estimate with reliability (for example, for some intangible assets). The cost approach is normally categorised into two methods:
- replacement cost (in basic terms, the cost of replicating functionality)
- reproduction cost (in basic terms, the cost of recreating the asset).
The probabilistic approach is often used to derive a valuation based on a range of outcomes or discrete events. This approach is commonly used to value an item where several layers of uncertainty and co-dependability exist (for instance, from a budgetary, time or variables perspective).
Probabilistic approaches are often used to value items such as research and development, mining projects or the option-embedded elements of securities. Simulation analysis (for example, Monte Carlo) and lattice-based models (also known as decision-tree analysis) are examples of the probabilistic approach.
The approaches and methods described above comprise of only the first step in deriving the value of an item. When you are determining the market value of something for tax purposes, you need to identify a number of variables and incorporate them into the derivation of the market value. We discuss some examples of these below.