Factors in Determining the Level of Future Maintainable Earnings
- Arnold Shields
- Jan 27, 2010
- 3 min read
Updated: Jun 23
Why Valuation Assumptions Matter
Business valuations rely on a number of subjective assumptions, and one of the most critical is the level of expected future profitability. Without a well-supported forecast of profits, the valuation basis is weakened and vulnerable to challenge.
It's common practice to use the average of the past three years’ earnings to project future profits. While this may be a reasonable foundation, many valuations fail to explain why this method is appropriate in the specific context. A valuation is only as strong as the rationale behind its assumptions.
When to Use Future Maintainable Earnings vs Discounted Cash Flow
The Future Maintainable Earnings (FME) methodology is suitable when a business’s profits are expected to remain stable. But when significant growth or changes are anticipated, such as scaling operations, entering new markets, or restructuring, the Discounted Cash Flow (DCF) method becomes more appropriate.
The Challenge with Private Companies
Private company financials are often incomplete, outdated, or poorly presented. This limits our ability to rely on forecasts. As a result, valuers must place greater weight on past performance, carefully adjusted for reliability and sustainability.
How We Assess Future Profitability
At Dolman Bateman, we analyse future earnings potential by systematically reviewing historical performance and stress-testing it against a range of qualitative and quantitative factors. We break this down into four key areas:
1. Sales
How reliant is the business on a small number of customers?
Is business success tied to physical location?
What are the lease terms and renewal options?
Are competitors increasing or decreasing?
Does the business export? If so:
Lead time
Demand stability
Impact of exchange rates
Is the business reliant on key staff?
What are the barriers to entry?
Are sales consistent and sustainable?
Does the business rely on key contracts?
2. Gross Margins
Are key products imported?
Lead time, supply risk, and exchange rate volatility
Are there any delivery or quality issues from suppliers?
Are there existing licensing or supply agreements in place?
Are margins stable, improving, or deteriorating?
3. Expenses
Are expenses consistent over time?
What is the mix of fixed vs variable expenses?
Are costs controllable or locked in?
4. Profits and Sustainability
How dependent is the business on the shareholders or directors?
Are their roles easily replaceable?
What are the broader industry trends?
Are profits realistic and sustainable in the current market?
Who are the major competitors?
Are there buyer limitations that might affect value?
Does the business rely on specific key staff?
Are budgets realistic and in place?
Will future capital investment be required?
How reliable is the financial information provided?
The Role of Professional Judgement
These are just some of the questions we ask when assessing future profitability. Combined with our decades of experience in forensic accounting and business valuation, this methodical approach helps ensure each valuation is robust, defensible, and fit for purpose, whether for litigation, sale, restructuring, or internal planning.
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Disclaimer:
The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.
