Valuation methods for cash cow businesses

If you need to get a top notch business appraisal, consider using a number of different business valuation methods. This multi-method approach to business valuation is standard in professionally prepared appraisals.

The reason is that each method sheds a different light on business value. Hence, seeing the results from a number of methods gives you a well rounded picture of what the business is worth.

One way to handle your valuation is to apply every available method. In practice though, you may decide to choose some valuation methods over others. A specific choice of valuation methods can be more suitable for your situation and significantly reduce the complexity of your business appraisal.

Special business valuation case: the cash cow company

One special case is the so-called cash cow company. These businesses are steady earners that generate consistent returns for their owners despite changes in the economic conditions, competitive pressures and even ownership transitions.

Here are some examples of cash cow companies:

• Established providers of niche products and services to a number of corporate or government customers.
• Firms enjoying long-term contracts with their customers. Examples are contractors to national governments such as the US Federal agencies.
• Companies in a highly protected market with barriers established by unique technology, regulatory requirements or high initial capital investment needs.
• Businesses that have established themselves as institutions in their market. This tends to result in stable recurring earnings from a large number of loyal customers.

Valuation methods used for cash cow businesses

Here are some method suggestions that you can apply to valuation of a steady earner company:

• Direct capitalization valuation methods
• Market comparison to recently sold businesses
• Asset based valuation methods that measure business goodwill

Capitalization methods such as the Multiple of Discretionary Earnings technique are especially well suited for appraisals of these businesses. The methods reply upon a single measure of business earnings to estimate what the business is worth. This works because it is relatively straightforward to predict the earnings of the cash cow business based on its historic performance.

Predictable income stream prospects make cash cow companies highly desirable acquisition targets. As a result there are usually plenty of comparable business sales. You can use valuation multiples derived from such transactions to estimate your business value with considerable accuracy.

Recurrent earnings that characterize cash cow businesses usually point to a loyal customer base. Firms with strong customer following tend to build highly valuable business goodwill. You can use the Capitalized Excess Earnings method to measure the goodwill as well as the total business enterprise value.

See Valuation Tour