A common income-based small business valuation method that establishes the business value by dividing the expected business economic benefit, such as the seller’s discretionary cash flow, by the capitalization rate.
What It Means
Capitalization of Earnings Method determines the business value using a single measure of the expected business economic benefit as the numerator. This is divided by the capitalization rate that represents the risk associated with receiving this benefit in the future.
We discuss the capitalization and discounting business valuation methods in the Guide and show that the two are equivalent if the business earnings grow at a constant rate.
In using this valuation method, care must be given to the proper selection of the economic benefit being capitalized and the appropriate capitalization rate.
Accurate matching of the income being capitalized and selection of the capitalization rate are the key advantages of the Multiple of Discretionary Earnings business valuation method.