Which Valuation Method Should One Use? The Pros and Cons of the Two Most Common Approaches

Sooner or later, every business owner faces the same question: Do I need a valuation—and if so, how should I go about it?
In our previous article, we explored the why. Now we’re looking at the how—specifically, the most widely used valuation methods for small and mid-sized businesses.

Two common approaches are the Discounted Cash Flow (DCF) method and multiples-based valuations. Here’s a quick overview of both, to help you decide which might be right for your situation.

1. Discounted Cash Flow (DCF): Best When the Future Is Predictable

The DCF method estimates the company’s future ability to generate cash—typically over a 4- to 7-year period—and then calculates the present value of those future cash flows using an appropriate discount rate. This forecast window is known as the explicit period.

On top of that, the model includes a projection for the period beyond—usually assuming steady, moderate growth. This is called the terminal value. Together, the present value of future cash flows and the terminal value form the total valuation.

In short: DCF is ideal when the business has a clear, reliable growth path.

2. Multiples-Based Valuation: Fast, Market-Oriented, and Widely Used

This method relies on valuation multiples (e.g. based on EBITDA, EBIT, or revenue) and is applied in two main ways:

• Based on market transactions: This looks at what similar companies have sold for—what multiples buyers paid in real-world deals.
• Based on listed comparables: Here, we take the current trading multiples of comparable public companies and adjust them for private businesses. Public firms typically command higher multiples due to their transparency and efficiency, so a private company discount is usually applied.

The key advantage? It’s relatively quick and based on real market data—unlike DCF, which can require extensive forecasting and preparation.

When to Use Which?

Ideally, both methods should arrive at similar values. But if they don’t, it’s a signal to revisit your assumptions and data inputs.

In our experience, most SMEs struggle to produce reliable financial forecasts—even six months out, let alone several years. In such cases, a DCF model can be not just inaccurate, but misleading.

If there’s no strong, well-supported forecast in place, it’s usually better to rely on a multiples-based valuation. It carries fewer assumptions—and fewer opportunities for error.

Multiples Aren’t Perfect Either

Of course, multiples-based valuations come with their own caveats, especially for privately owned businesses:

• Are the owners and family members drawing market-based salaries—or are they optimizing for taxes?
• Are there personal expenses being run through the company (e.g. travel, entertainment, personal car use)?
• Are transactions with related parties conducted at market rates?

These factors can all distort EBITDA or EBIT—and by extension, the entire valuation. To get to a fair, realistic number, adjustments must be made. And that’s something only an experienced valuer can do with confidence.

Bottom Line: No One-Size-Fits-All Approach

Valuing a business isn’t a plug-and-play exercise. There’s no universal formula that works in every case. The best method depends on the specific context, the quality of available data, and the purpose of the valuation.

The more reliable the information and the deeper the expertise of the analyst, the more accurate and defensible the result—whether you’re using DCF, multiples, or a blend of both.