PART 2 OF 4: The Three Core Valuation Approaches

Income, market, and asset methods, and how appraisers use them.

Valuation professionals generally analyze a practice through three recognized approaches. Each looks at value from a different angle, and a thorough valuation often considers more than one before arriving at a conclusion. This article explains the three approaches and where each fits.

The income approach

The income approach values a practice based on the earnings it is expected to generate, on the premise that a buyer is ultimately purchasing a future stream of income. Common methods capitalize a single measure of normalized earnings or discount projected future earnings to present value. The approach depends heavily on two things: a reliable measure of the practice's true earnings, and an appropriate rate that reflects the risk of those earnings. Because it centers on earning power, the income approach is frequently central to valuing an ongoing practice.

The market approach

The market approach values a practice by reference to what comparable practices have actually sold for, often expressed through valuation multiples drawn from transaction data. Its strength is that it reflects real market behavior rather than theory. Its limitation is the availability and comparability of data — practices differ by specialty, size, location, and payer mix, and truly comparable transactions can be scarce. Appraisers adjust for these differences when applying market data.

The asset approach

The asset approach values a practice as the net value of its assets, tangible and intangible, less its liabilities. It is often most relevant where a practice's value is driven by its equipment and hard assets, or where a practice is not a strong ongoing earnings generator. For many successful practices, however, the asset approach understates value because it may not fully capture goodwill and other intangibles.

Reconciling the approaches

A careful appraiser does not simply average the results of the three approaches. Instead, the appraiser weighs them according to the nature of the practice and the purpose of the valuation, giving greater weight to the approach or approaches best supported by the facts. The reconciliation — the reasoning behind how the approaches are weighted — is often where the real analysis lies.

How West Coast Health Law Can Help

We help practice owners understand how appraisers apply the income, market, and asset approaches, and how the choice among them affects the resulting value.

West Coast Health Law offers a FREE consultation which you may schedule by clicking the button on our website.

This article is provided for general informational purposes only and does not constitute legal advice or create an attorney-client relationship. Laws change and every situation is different; consult a qualified attorney about your specific circumstances.