Business Valuation Methods Explained: Income, Market, and Asset Approaches

Appraisers value a business three ways: by what its future earnings are worth today (the income approach), by what similar businesses sold for (the market approach), and by what its assets are worth after debts (the asset approach). The AICPA’s valuation standard and the IRS’s valuation guidelines both tell an appraiser to consider all three, then use judgment about which to rely on. For a profitable lower-middle-market company the weight usually falls on earnings, and buyers compress the first two approaches into one working number: a multiple of adjusted EBITDA.

What the standards call the three approaches

VS Section 100, the AICPA’s standard for CPAs who estimate business value, says in paragraph .31 that the analyst “should consider the three most common valuation approaches”: income, asset and market. Section 4.48.4 of the Internal Revenue Manual gives IRS appraisers the same three and adds, “Consideration should be given to all three approaches.” The older foundation is Revenue Ruling 59-60, a 1959 IRS ruling on valuing closely held stock for estate and gift tax.

The ruling lists eight factors: the nature and history of the business, the economic and industry outlook, book value, earning capacity, dividend-paying capacity, goodwill, past sales of the stock, and the market price of similar public companies. The IRS manual’s checklist follows them. The ruling offers no formula: “No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases.”

Approach	The question it answers	Methods the standards name
Income	What are expected earnings or cash flows worth in today’s dollars?	Capitalization of earnings; discounted cash flow
Market	What have buyers paid for similar businesses?	Guideline transactions; guideline public companies
Asset	What are the assets worth once debts come out?	Adjusted net asset (adjusted book value)

Income approach: what the next years of earnings are worth today

The income approach turns expected earnings or cash flows into one value today. Both of its methods start from normalized earnings, which is why documented add-backs matter.

Capitalization of earnings divides one representative year of normalized earnings by a capitalization rate: the return the buyer requires less the growth it expects. Riskier, slower businesses get higher rates and lower values. Buyers talk in multiples, and the AICPA glossary defines a multiple as “the inverse of the capitalization rate.” A 20% rate turns $1.0 million of earnings into $5.0 million of value, a 5.0× multiple; a 25% rate turns the same earnings into $4.0 million. Five points on the rate moved the answer by a fifth.

Discounted cash flow (DCF) forecasts cash year by year, adds a terminal value for the years after the forecast, and discounts the total at a rate that reflects risk. It earns its keep when growth or margins will change; for a steady business a single-period capitalization can be enough. Either way the rate is where the judgment sits. Revenue Ruling 59-60 called choosing it “one of the most difficult problems in valuation” and pointed to the nature of the business, the risk involved and the stability of earnings.

The market approach starts from completed sales

The market approach prices a company off sales of similar ones, and it has two main methods. The guideline transaction method (the glossary also calls it the merger and acquisition method) takes pricing multiples from sales of whole companies in the same or similar lines of business. The guideline public company method takes them from the stock prices of listed companies.

Size is the catch. Public companies are “typically much larger than a private subject company,” Mercer Capital notes, so their multiples may need adjusting for size and risk. Sales of private companies span the size range, but each happened on one date, much of the data is self-reported, and a headline price may include an earnout, an employment agreement or seller financing that changes what the seller really received (why multiples differ by size).

What the market approach looks like in deal data

This is the raw material of a guideline-transaction analysis: trailing EV/EBITDA for disclosed deals with targets at or below $25M of EBITDA, from Bankerly’s transaction database, as of October 2026. The p25 and p75 columns bracket the middle half of deals in each sector; n is the number of deals behind the row.

Sector	p25	Median	p75	n
Aerospace & Defense	9.3×	10.5×	13.0×	18
Software & Technology	6.9×	8.3×	10.1×	23
Business Services	4.8×	7.6×	10.0×	32
Energy & Utilities	4.4×	6.7×	8.8×	22

Disclosed deals skew larger and better run than a typical owner-operated company, so a median here is a reference point, not a price. The spread matters more: in business services the middle half of deals runs from 4.8× to 10.0×, more than five turns wide, which on a hypothetical $2.0 million of adjusted EBITDA is the gap between $9.6 million and $20.0 million. Placing one company inside that spread is the real work of a market-approach valuation. The full table, with revenue multiples, is at M&A multiples by industry. The free valuation calculator applies the same figures to numbers you enter; it is one option next to a broker’s opinion of value or a formal appraisal, and its output is an educational estimate, not an appraisal.

When the balance sheet sets the price

The asset approach values a company as what it owns less what it owes. A frequently used method, adjusted net asset (the glossary calls it adjusted book value), restates every asset and liability to fair market value, including off-balance-sheet, intangible and contingent items.

For a profitable operating company this approach rarely sets the price. Mercer Capital notes that net asset value typically leaves out the value of intangible assets, and Revenue Ruling 59-60 explains where that value comes from: goodwill “rests upon the excess of net earnings over and above a fair return on the net tangible assets” (goodwill and intangibles). The sources name three situations where assets do govern:

• Holding companies. The ruling says an investment or real estate holding company’s value is closely related to its underlying assets, and gives adjusted net worth more weight there than earnings.
• Asset-heavy operating companies. Mercer Capital calls the approach appropriate for capital-intensive operating companies, while noting that sometimes the operating company is worth more than its assets.
• Companies that lose money. CBIZ says the adjusted net asset method fits “when losses are continually generated,” or when earnings-based methods indicate less than net asset value. The assets then act as a floor: what a sale of everything, net of debts, would bring.

Fair market value, investment value, and the strategic buyer

Before choosing an approach, an appraiser picks a standard of value, the type of value being measured, such as fair market value or investment value. CBIZ says the right one depends on the purpose of the valuation, the facts, and the statutes and case law that apply.

Revenue Ruling 59-60 describes fair market value, the estate and gift tax standard, as the price at which property would change hands between a willing buyer and a willing seller, neither under compulsion and both reasonably informed. Those parties are hypothetical, and Mercer Capital notes they negotiate over economic value, not over synergies that only one buyer could capture.

Investment value is “the value to a particular investor based on individual investment requirements and expectations,” per the AICPA glossary. A buyer that can cut costs by combining operations, or wants to enter a market or remove a competitor, sees more earnings in the same company than the seller does, and CBIZ says strategic value can run significantly higher than other standards for those reasons. The IRS manual likewise tells its appraisers to consider “the impact of strategic or synergistic contributions to value.” An appraisal at fair market value and a strategic bidder’s offer can therefore both be defensible and still differ, because fair market value, Mercer Capital writes, “will likely not reflect the highest price that might be obtained” (strategic buyers and synergies).

How buyers price a deal in practice

In the lower middle market the working number is a multiple of adjusted EBITDA. The accounting firm Lutz says buyers focus on adjusted EBITDA as their primary metric and “typically apply a market multiple” to it when setting a purchase price. The multiple is market-approach evidence, the earnings figure comes from the normalization work behind the income approach, and the arithmetic is capitalization in disguise: a 5.0× multiple is a 20% capitalization rate (EBITDA, SDE and cash flow covers how the earnings base changes with company size).

Multiple first, model second

Buyers then test the number. A financial buyer builds a leveraged buyout (LBO) model, which Benchmark International describes as “an analytical tool used to determine the maximum price a buyer could pay” and still earn an appropriate return. Its inputs are the target’s free cash flow, the return equity investors require and the lenders’ terms. Wall Street Prep, a finance training firm, calls the same exercise ability-to-pay analysis and notes that sponsors’ higher hurdle rates push the implied value below a traditional DCF’s, all else equal (how buyers model your business). A DCF sits behind the multiple too: Mercer Capital calls single-period capitalization “an algebraic simplification of its more detailed DCF counterpart,” so a DCF spells out the growth and risk a multiple already assumes.

Why rules of thumb mislead

A rule of thumb prices a business with one fixed ratio, such as a percentage of annual sales. The AICPA glossary defines it as “a mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry specific.” VS Section 100 says it “is typically a reasonableness check against other methods used and should generally not be used as the only method to estimate the value of the subject interest.”

The reason is what one ratio leaves out. Take two hypothetical companies with $10 million of revenue each. One earns a 5% EBITDA margin ($0.5 million), the other 20% ($2.0 million). A rule of one times revenue prices both at $10 million; at a hypothetical 6.0× EBITDA they are worth $3.0 million and $12.0 million. Typical ranges by industry are in how much is my business worth, as orientation rather than a method.

Weighing and reconciling the results

The last step is reconciliation. VS Section 100 has the analyst “correlate and reconcile the results obtained under the different approaches and methods used,” assess how reliable each is, and decide whether the conclusion should rest on one approach or a combination. The IRS manual leaves the choice to professional judgment, and neither document sets weights. Considering an approach is not the same as using it: CBIZ notes it is “acceptable to dismiss an approach if there is valid reasoning behind doing so.”

Revenue Ruling 59-60 explains why no formula does the weighting. Earnings get primary consideration for companies that sell products or services to the public, while assets can carry the greatest weight for an investment or holding company. Averaging is ruled out, since “no useful purpose is served by taking an average of several factors” and basing the valuation on the result. For operating businesses, CBIZ says the income approach is often the primary approach, with the asset approach setting a floor.

This article is educational, not valuation, tax, legal or investment advice, and its figures are not an appraisal of any company. Standards and tax rules change and vary by situation; an owner’s own CPA, attorney or credentialed appraiser decides what applies.

Sources

• IRS: IRM 4.48.4, Business Valuation Guidelines
• Rosen Law Firm: IRS Revenue Ruling 59-60 (full text)
• AICPA: VS Section 100, Statement on Standards for Valuation Services (PDF)
• CBIZ: Part 3: Understanding Your Business Valuation, Approaches and Discounts
• CBIZ: What Is Value? Standards of Value
• Mercer Capital: Understand the Income Approach in a Business Valuation
• Mercer Capital: Understand the Market Approach in a Business Valuation
• Mercer Capital: Understand the Asset Approach in a Business Valuation
• Mercer Capital: Fair Market Value vs. The Real World
• Lutz: Understanding EBITDA and Normalizing Adjustments
• Benchmark International: What Is a Leveraged Buyout Analysis?
• Wall Street Prep: Ability-to-Pay Analysis (ATP)