Income Method
| Capitalisation Rate | Multiple |
|---|---|
| 100% | 1.0 |
| 50% | 2.0 |
| 33% | 3.0 |
| 25% | 4.0 |
| 20% | 5.0 |
This method is also known by various other names, such as:
- Capitalisation of Future Maintainable Earnings (FME);
- Capitalisation of Future Maintainable Profits
- Capitalisation of Maintainable Profits
The Capitalisation of Earnings Method is classified as an income approach under the
International Valuation Standards (IVS). When used for SME valuations, it is commonly based on an EBITDA standard of profit.
The capitalisation rate/multiple is commonly calculated using “build up” methods such as
Capital Asset Pricing Model (CAPM) or Weighted Average Cost of Capital (WACC).
Importantly, the various methods used to calculate the capitalisation rate/multiple are
designed to replicate what a logical investor would accept as a return for an investment in an
SME business. It allows comparison to other forms of assets they may otherwise choose to
invest in.
Comparable Transactions (Market) Method
This method involves valuation through comparison to other businesses which have sold in the
marketplace. The comparative analysis can involve a range of units of comparison, such as one
owner PEBITDA profit, under management EBITDA profit, revenue, recurring revenue etc. Market
multiples which correspond to these units of comparison are then derived by dividing the
business sales price by the appropriate unit of comparison. (e.g. multiple based on dividing sale
price of the business by revenue or multiple based on dividing the sale price of a business by
PEBITDA or EBITDA profit).
Comparison by way of revenue (or some form of recurring revenue) is generally limited to a few
business types such as smaller accounting practices, mortgage brokers, financial planners, real
estate rent rolls etc.
The majority of SME businesses valued by applying a market multiple/ capitalisation rate to
either a PEBITDA or EBITDA standard of profit. In some states of Australia this has been known
as the “Market ROI Approach”.
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