Future Maintainable Earnings - Business Valuation Methodologies
- Arnold Shields
- Jan 21, 2010
- 2 min read
Updated: Jun 23
The Future Maintainable Earnings (FME) method is the most common approach for valuing small-to-medium profitable businesses in Australia. It offers a simplified and practical alternative to the more complex Discounted Cash Flow (DCF) model.
While the DCF method is widely accepted as the gold standard in valuation theory, it is often impractical for smaller businesses due to unreliable or unavailable long-term cash flow data. The FME method addresses this by focusing on the business’s expected ongoing earnings and applying a capitalisation rate that reflects the risk and return profile of the business.
Key Components of an Earnings-Based Valuation
Earnings-based valuations involve capitalising the future maintainable earnings of a business at an appropriate multiple (also known as a capitalisation rate). This requires careful consideration of the following:
Future Maintainable Earnings (FME): Analysed with reference to historical and forecast results, adjusted for one-off items and normalisation, and tested against industry and economic trends.
Capitalisation Rate: Reflects the risk-return trade-off for an investor, incorporating business risk, market conditions, growth prospects, and other investment alternatives.
Surplus Assets and Liabilities: Assets or liabilities not essential to the ongoing operation of the business are assessed and excluded from the earnings calculation.
Our Future Maintainable Earnings Valuation Process
At Dolman Bateman, our structured valuation process includes the following steps:
Financial Analysis: Examination of the business’s financial statements to assess profitability, stability, and recurring income.
Balance Sheet Review: Separation of business assets and liabilities (used in the day-to-day operations) from surplus or unrelated items.
Tangible Asset Valuation: Adjustment of tangible assets and liabilities to reflect their net realisable value.
Determine Future Maintainable Earnings: Adjust past earnings to reflect a realistic ongoing level of profitability.
Capitalisation Rate Determination: Apply an appropriate rate based on industry, economic, and business-specific risks.
Calculate Business Value: Multiply the FME by the capitalisation rate to derive the business's enterprise value.
Goodwill Calculation: Subtract the net tangible asset value from the total business value to determine goodwill.
Company Valuation: Final value is calculated as the sum of net tangible assets and goodwill.
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.
