Business valuation methods, explained plainly.

What is business valuation?

Business valuation is the process of arriving at an economically defensible estimate of what a business, or a stake in it, is worth on a given date, for a given purpose. The word "valuation" hides an important qualifier: value for what purpose, as of when. A valuation prepared for a fundraise, a share transfer under FEMA, an ESOP grant, a merger swap ratio, a dispute, or a tax provision can legitimately produce different numbers for the same company — because the purpose, the prescribed method, and the valuation date all differ.

Almost every valuation assignment draws from three core approaches. A competent report rarely relies on just one; it triangulates using at least two, and explains why the primary method was chosen and how the others corroborate (or don't).

The three approaches, side by side

Each approach answers a different question about the same business. Knowing which question your engagement is actually asking is most of the battle.

A fourth "approach" you'll hear about — replacement cost — is really a variant of the asset approach, useful mainly for capital-intensive businesses where rebuilding cost is more relevant than book value.

Income approach — Discounted Cash Flow (DCF)

DCF says a business is worth the sum of its future free cash flows, each discounted back to today at a rate that reflects the risk of actually receiving them. Mechanically, it has four moving parts:

• Forecast free cash flows — usually 5 years, built from a revenue and margin projection, less tax, less reinvestment (capex and working capital).
• Discount rate (WACC) — the blended cost of equity and debt, reflecting the business's risk. This is the single most judgment-heavy, most contested input in the whole model.
• Terminal value — the value of all cash flows beyond the explicit forecast period, usually via a perpetuity growth formula or an exit multiple.
• Present value — each year's cash flow (and the terminal value) discounted back to the valuation date and summed.

DCF is powerful because it captures growth, brand and future profitability that a balance sheet can never show. It is also the easiest method to get quietly wrong, because small changes to the discount rate or the terminal growth rate move the answer a lot — always stress-test the output against a range of reasonable assumptions, not a single point estimate.

Worked example — a simplified 3-year DCF

A teaching example only, with deliberately round numbers, to show the mechanics. Assume free cash flow of ₹100 in Year 1, growing 10% a year, discounted at a WACC of 12%, with a terminal value at the end of Year 3.

Terminal value at the end of Year 3, using the Gordon growth (perpetuity) formula with a 4% long-run growth rate: Year 4 cash flow = ₹121 × 1.04 = ₹125.84 lakh. Terminal value = 125.84 ÷ (0.12 − 0.04) = ₹1,573.0 lakh. Discounted back three years at the same 0.712 factor: 1,573.0 × 0.712 = ₹1,119.6 lakh (present value of the terminal value).

Enterprise value = present value of explicit cash flows (₹263.1 lakh) + present value of terminal value (₹1,119.6 lakh) = ₹1,382.7 lakh, i.e. roughly ₹13.83 crore. If the company carries net debt, subtract it to arrive at equity value; if there is surplus cash beyond operating needs, add it back.

Notice how much of the total value (about 81% here) sits in the terminal value — this is normal for a 3-year explicit forecast, but it's exactly why the terminal growth rate and WACC deserve as much scrutiny as the explicit-period forecast, if not more.

Asset approach — Net Asset Value (NAV)

NAV values the business as the sum of its identifiable assets at fair value, less all liabilities. In its simplest form it's book NAV (straight from the balance sheet); a more rigorous version restates key assets — land, buildings, investments — to fair value before netting off liabilities, since book value on older assets rarely reflects current worth.

NAV is the natural primary method for holding companies, investment companies, and businesses being wound up or liquidated, where the question genuinely is "what are the assets worth" rather than "what can this business earn." Even when DCF is the primary method, NAV is routinely computed as a sanity-check floor — a going concern should rarely be worth less than its net assets, and if a DCF comes out below NAV, that's a signal to revisit the DCF assumptions, not necessarily to prefer the DCF number.

Market approach — Comparable Company Method (CCM)

CCM values a business by reference to how the market prices genuinely similar businesses — either listed peers (trading multiples such as EV/EBITDA, P/E, EV/Revenue) or recent M&A transactions in the same sector (transaction multiples, which usually embed a control premium). The comparable's multiple is applied to the subject company's corresponding metric, then adjusted for differences in size, growth, margin and liquidity.

The method lives or dies on comparability. For a niche Indian SME with no truly similar listed peer, forcing a CCM often does more harm than good — a valuer should be honest when comparables are too different to be meaningful, rather than presenting a false precision. Where good comparables exist, CCM is an excellent cross-check against a DCF, because it reflects what the market is actually paying today rather than a projection.

Practical notes for a practising CA

• Match the method to the purpose first. Company law, FEMA, income tax and commercial fundraising can each prescribe or expect a different method or a different valuer qualification — confirm the applicable rule before starting, not after drafting the report.
• Document every judgment call. The discount rate build-up, the terminal growth assumption, the comparables chosen and rejected, and the reasons for the primary method — all of this needs to be on file, because these are exactly the points a regulator, an assessing officer, or an opposing valuer in a dispute will test first.
• Cross-check, don't cherry-pick. Running two methods and quietly reporting only the one that supports the client's preferred number is a credibility risk. A gap between methods is normal and should be explained, not hidden.
• Valuation date discipline. Use information available as of the valuation date; a valuer generally should not use hindsight (a deal signed after the valuation date, for instance) to justify the number, except in narrow, well-recognised circumstances.
• Watch for prescribed formats. Certain statutory valuations (for example, under specific income-tax provisions for unquoted equity shares) require a specific prescribed formula rather than open judgment — always verify the current prescribed method and applicable rule on the income-tax and MCA/IBBI portals before finalising, since these have been amended over time.

None of this is TatvaBooks-specific — valuation is a judgment exercise, not a bookkeeping one. Where TatvaBooks does help is upstream: clean, GST-correct books and accurate historical financials are the raw material every valuation model — DCF, NAV or CCM — starts from. If your client's books are behind or reconciled loosely, that's usually where a valuation assignment stalls first. See TatvaBooks for Chartered Accountants or our pricing page.

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