Approaches to Value in a Nutshell

Ask any appraiser about the ways to figure out the value of an asset or a business. You will hear that there are only three ways to do this. You may be surprised that all these smart people managed to come up with is just three approaches to valuation. Yet this is true, only three ways of measuring value exist:

Asset or cost approach

Under this approach the question is this, “What would it cost to come up with an asset that is identical or at least similar to the one being valued?” If you need some useful asset today, you would not likely pay more for it than the cost of a comparable asset.

This, of course, implies that a comparable asset exists. Imagine trying to place a cost on a truly unique work of art. There may not be anything to compare it against. So the cost approach would not work to put a value on a one of a kind asset.

Income approach

You can also ask this question, “Given the risk of owning an income producing asset such as a business, what return can I expect from it?” The income approach is versatile enough to put a value on businesses, as well as tangible and intangible assets such as intellectual property. In fact, you can measure the value of any assets using the income approach so long as the asset generates an income.

Note that when you use the income approach you focus on the specifics of the asset you value. Comparing it to other things is not what the income approach is about.

Market approach

But what if you are dealing with an asset that can be readily sold in the open market? Then you can ask this question, “What do comparable assets sell for?”  A well established market with plenty of buyers and sellers tends to set asset prices within narrow limits. As a result, you can collect data on market prices to figure out what your particular asset may be worth. Of course, you need to be sure your comparison is relevant.

Knowing your market niche is key to establishing value under the market comparable approach. For example, an expert in specific works of art or rare collectibles would have the knowledge needed to put a price on an item that closely matches the market expectations.

So there you have it. You can choose the approach to value or pick several approaches at once to figure out the value of just about anything.

See Valuation Tour