(Posted June 2026)
Business valuations are a recurring topic on the CPA Common Final Examination (CFE). While the calculations themselves are not difficult, candidates often struggle with identifying and justifying relevant adjustments and interpreting the result of the valuation. This blog will review the most common valuation approaches and highlight how to turn your calculations into stronger case writing.
Types of Business Valuations
There are two primary approaches to business valuations: transaction-based and asset-based. The case facts will typically signal which approach to use.
Transaction-Based
Transaction-based valuations are the most frequently tested. They focus on the value of the entity’s ongoing operations (profitability or cash flow), making them appropriate when the business is a going concern.
In most cases, the required method will be triggered by the multiplier provided. For example, a multiple based on EBITDA indicates a capitalized EBITDA approach or a multiple based on cash flow indicates a capitalized cash flow approach.
The following steps outline the calculation:
- Normalize earnings or cash flow
Start with net income before tax. Adjust for accounting issues triggered in the case (e.g., incorrect revenue recognition), remove non-recurring or non-operating items (e.g., one-time lawsuit settlement), and adjust items to market-based amounts (e.g., owner compensation).
- Convert to sustainable after-tax performance
Deduct income taxes. Adjust for non-cash items (e.g., depreciation) and deduct sustaining capital expenditures net of tax shield (if using cash flow valuation).
- Calculate equity value
Apply the multiplier or discount rate selected. Add net realizable value of redundant (non-operating) assets and deduct market value of debt.
Asset-Based
In contrast, asset-based valuations focus on the value of the entity’s underlying assets rather than its earnings. They are more applicable when an entity is no longer a going concern (e.g., when liquidation is likely or operations are no longer sustainable). Asset-based valuations are less commonly tested on the CFE.
Start the calculation with the book value of net equity (assets – liabilities). Adjust for market value differentials (e.g., increase value if market value of assets is higher). Deduct income taxes on disposal and other costs of disposal to come to the total value of equity.
Case Writing Tips:
When performing a valuation in a case setting, remember the following:
- Aim for breadth: Include a range of adjustments across both accounting and normalizing items.
- Focus on depth: Support your adjustments by explaining why each adjustment normalizes income or cash flows, using case facts.
- Consider sensitivity: For example, evaluate whether the current year is more representative of earnings/cash flows than an average of the last two years.
- Justify your inputs: Explain the multiplier or discount rate selected, especially if a range is provided. This may involve supporting the reason why the business is comparable to other companies that have been sold recently.
- Support reasonability: Compare the value to the selling or purchase price and determine whether it is reasonable. Remember to consider the percentage ownership when comparing value to selling price.
- Consider qualitative analysis: Use the required to guide whether you also need to analyze the decision qualitatively (pros/cons, valuation methodology, etc.).
- Conclude: Provide a definitive recommendation based on your results. Answer the user’s question – what should they do? Consider your role and who you work for so that your conclusion makes sense.
Strong valuation responses go beyond the calculation. They clearly justify assumptions and lead to a well-supported conclusion