Business Valuation Methods Explained | IBV™

Capitalisation of future maintainable earnings is widely used for established, profitable businesses with reasonably sustainable earnings. Its suitability depends on the business, the available evidence and the purpose of the valuation. The idea is straightforward: identify the level of earnings the business can reasonably sustain, then apply a multiple that reflects the risk and growth prospects of those earnings.

Step one: maintainable earnings. The valuer starts with historical results, usually several years, and normalises them. That means adding back genuinely personal or one-off expenses, replacing owner wages with a commercial salary for the work actually done, adjusting related-party rent to a market level and removing unusual income. The aim is a figure a new owner could expect to repeat. Earnings may be measured before interest and tax (EBIT), before depreciation as well (EBITDA), or, for owner-operated businesses, as owner's discretionary earnings—the measure must match the multiple used.

Step two: the multiple. The capitalisation multiple reflects risk. Customer concentration, reliance on the owner, contract length, lease security, staff stability, industry conditions and growth prospects all push the multiple up or down. A market-derived earnings multiple draws on comparable transactions, whereas an independently developed capitalisation rate is built from supportable risk and growth assumptions. In a simple capitalisation model, the multiple is the reciprocal of the capitalisation rate. Their derivations differ, but both require evidence and consistency with the earnings measure; neither should be borrowed from a headline. Our article on EBITDA multiples explains why.

Step three: adjustments. Capitalising EBIT or EBITDA generally indicates an enterprise-level operating value; shareholder-level earnings can indicate equity value directly. Cash, non-operating assets, working capital and debt must be reconciled consistently with the selected value definition, without double-counting, before assessing the specified ownership interest.

This method is widely understood, works well when earnings are reasonably stable and is often a good fit for tax, family law and transaction purposes.

Asset-based methods value the business by reference to its assets less its liabilities. The two common versions are net assets on a going-concern basis and net realisable value on an orderly realisation or liquidation basis.

Asset-based methods are particularly relevant to asset-intensive businesses, investment entities and businesses with weak or unsustainable earnings. Net asset or realisation values may provide an important alternative indication, but they do not automatically establish a minimum value for every business or ownership interest. Liabilities, realisation costs, contractual restrictions, tax, liquidation assumptions and the rights attached to the interest can materially change the comparison. The ability and authority to realise assets also matter: a minority shareholder cannot necessarily require the business to sell its assets.

Asset values often need separate input. Property and specialised plant may require an independent property or plant valuer, and the business valuer will rely on and refer to that work.

Market methods compare the business with prices achieved for similar businesses. In practice, reliable private-company transaction data in Australia is limited, and the details that matter—what was included, how the price was paid, the earnings definition used—are often unknown.

Industry rules of thumb, such as a multiple of fees for a practice or of annual income for a rent roll, fall into this category. They can be a useful cross-check and are sometimes how buyers in an industry talk about price. They are rarely enough on their own, because they hide differences in profitability, retention and risk between one business and the next.

Choosing a method starts with the purpose and the evidence. A tax valuation needs a method the ATO will recognise as appropriate; the ATO's market valuation guidance expects the valuer to explain the choice. A family law matter needs a method both parties can understand and test. A business with stable profits generally points to capitalised earnings; one with volatile prospects may point to a DCF; one with thin profits and substantial assets may point to an asset approach.

The ATO highly recommends a secondary methodology where possible. A cross-check should use relevant, reliable evidence rather than add a method merely to satisfy a checklist; IVS does not require multiple methods for every valuation. A capitalised earnings value can be tested against net assets, implied market multiples or a simplified DCF. When different perspectives agree, confidence grows; when they disagree, the valuer should explain why.

IBV™ offers different levels of valuation engagement. A Calculated Value applies agreed calculation procedures, with the agreed method and limitations recorded in the Engagement Letter. A Limited Scope Conclusion of Value provides an independent conclusion within defined scope limitations; it is not subject to a universal one-or-two-method limit. A Full Conclusion of Value involves more extensive investigation and consideration of relevant methods, potentially including DCF where reliable forecasts are available. DCF is not mandatory for every comprehensive valuation. The appropriate scope, evidence requirements and methods are confirmed in the Engagement Letter. The Fixed Professional Fees page compares the three.

For a step-by-step guide to the whole process, read how to value a business in Australia. To discuss which method suits your business, book a Free Valuation Call.