A measure of business earnings used as the reference to calculate business value.
What It Means
Business valuation methods, especially those under the Income and Market valuation approaches, require that you estimate business earning power in order to determine business value. There are a number of accounting and economic ways to assess business income:
Accounting earnings basis choices
- Gross revenue or Net Sales
- Net after-tax income
Economic earnings basis choices
Once you choose the earnings basis, you can calculate business value in relation to it. The business value can then be represented as a multiple of the selected earnings basis, for example:
- 1.5 times the business gross revenues
- 3 times the seller’s discretionary cash flow
- 4.5 times the business EBITDA
Professional business appraisals typically use the cash flow-based, or economic earnings bases. This is because these income measures best represent the company’s earning capacity by accurately capturing the flow of capital through the business.
Typical earnings basis choices for small business appraisal
The net cash flow is the common choice for the well-known Discounted Cash Flow business valuation method. SDCF is preferred in small business valuations using the direct capitalization methods, such as the Multiple of Discretionary Earnings.
SDCF, along with business gross revenues, is also frequently used in market-based business valuation methods, such as the business valuation Comparative Transaction Method.