Prior to discussing each approach, it is important to frame the objective of the usual business appraisal. Typically, a business valuation is done to determine the "fair market value" of an interest in a business entity. The common definition of fair market value is "the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts." Because this implies a hypothetical buyer and seller, and not specific parties, the value is based on the "market."

Income Approach
Under the income approach, value is generated by the earnings or cash flow capabilities of the business. It is not a simple matter to determine the future earnings of a business. Operating a business is complex and the business owner faces risks from external and internal sources. Under this approach the amount of expected earnings must be quantified. In addition, the appropriate "discount rate" must be determined that represents an appropriate rate of return on the investment considering the how risky the business is.

The higher the risk of investing in the business, the higher the rate of return is required by a potential buyer as a reward. In other words, there is a risk-reward relationship when determining the appropriate discount rate in applying this approach.

A simple example of this concept is a certificate of deposit. The CD is for $10,000 and pays 10 percent interest (in the old days). Thus, it generates interest income of $1,000 per year. A formula can be stated as:

Value	X	Rate	=	Annual Income
$10,000	X	10%	=	$1,000

This formula can simplistically illustrate the concept of the income approach in a business valuation. If a business generates earnings of $100,000 per year and the appropriate rate for the buyer considering it is riskier than a CD is, say, 25%, then the value of the business is $400,000.

Value	=	Annual Income	divided by	Rate
Value	=	$100,000	divided by	25%

Thus, a buyer of the business invests $400,000 to generate $100,000 in earnings as a return on his or her investment

Asset Approach
Under the asset approach, the value of a business is its assets less its liabilities. Thus, all the company's assets must be identified including any intangible assets and separately valued. Liabilities then are subtracted to arrive at the value of the business. The difficulty in properly applying this approach is that it is difficult to determine the value of intangible assets (e.g., goodwill) using the asset approach alone. Frequently, another approach must also be used.

This approach is generally not used for valuing certain types of businesses such as service companies, asset-light businesses and minority interests in companies.

Market Approach
Under the market approach, the value of a business would tend to be similar to prices being paid for similar investments. For example, if comparable business have been selling for five times earnings, it is reasonable that a buyer of a particular business might expect to pay a similar multiple.

However, the problem with applying the market approach for valuations of smaller businesses is it is often difficult to obtain detailed information on the other business sales transactions. Thus, the market approach can often not be applied because of limitations in information.

For each approach - income, asset and market - several valuation methods exist. For example, under the income approach, the capitalization of a single-period earnings method and discounted future earnings are common methods. When and how each method is applied is beyond the scope of this article. Nevertheless, all applicable valuation methodologies should be used. As a result there may be several indications of value for the business using several methods. If applied properly, the different methods will then be reconciled in the final business value.

To qualify as an appraisal, business valuations must follow professional appraisal standards (e.g., Uniform Standards of Professional Appraisal Practice). This entails a lot of research and analysis. Sometimes, valuations are done without obtaining all the data and analyzing it. This might be fine to obtaining a "rough" indication of value but is never appropriate to get an accurate value.