"What's my company worth?"

The answer differs in each case because the buyer differs in each case. What your company is worth is determined differently as well, based on the standard of value: fair market value, strategic value, or some other standard.

In fair market value, it is the theoretical "willing" buyer. For strategic value, it may be a competitor who is willing to pay more because of potential synergies that could be realized by combining the two companies.

"How can someone not involved in my business put a value on it?" While an outsider will never fully understand all the nuances of a business the way an owner does, valuation professionals have established a systematic way to determine the value of any business, using three standard approaches: Market, Income and Asset.

The market approach arrives at an indication of value by comparing the company value to other similar companies. This is done by analyzing comparable publicly traded companies and comparable businesses that have recently been acquired. Successful use of this approach requires that the practitioner have access to a universe of arm's-length transactions involving companies similar to the subject company. Information on sales of comparable companies can be difficult to obtain for parties not privy to the transactions. When such data is publicly available, though the market approach is the most objective and understandable approach of the three.

The income approach looks more internally and estimates the company's value based on its ability to generate income. This estimate may be calculated by projecting cash flows into the future and discounting them back to the present at a stipulated rate of return—Discounted Cash Flow or DCF—or capitalizing a free cash flow base at an appropriate rate of return. The free cash flows used in this valuation method are defined as cash available to debt and equity holders after investment. This approach assumes that the income derived from the business will, to a large extent, control its value.

The asset approach is a general way of determining a value indication of a business's assets and/or equity interest using one or more methods based directly on the value of the assets of the business, less liabilities. This approach is used when the income stream generated by the business does not adequately reflect the value of the company; is usually employed with holding companies, not-for-profit companies and associations, start-up companies without an operating history, and/or distressed companies; and is rarely used when assessing the value of a viable operating entity.

Once the valuator has considered all three approaches for the subject company, he will choose the methods that best reflect the value of the business. This decision is based on the quality of the data available. This structured approach ensures that all the relevant facts will be considered in answering the question of what a company is worth.

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Contact Kimberly Griffiths at kgriffiths@reedbusiness.com.