Capitalisation of earnings valuation
Capitalisation of earnings values a business by multiplying its future maintainable earnings by a market-derived multiple — the method behind the large majority of Australian SME valuations.
It suits profitable businesses with three or more years of consistent trading, where a normalised earnings figure is a fair guide to what a new owner could sustain. We apply it as the primary method and cross-check it against net asset backing or comparable transactions.
Step by step
How a capitalisation of earnings valuation is built
Four steps, each documented so a third party can trace the reasoning from your raw financials to the concluded value.
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01
Normalise the earnings
Owner salary adjusted to a market rate for a replacement manager, related-party rent brought to market, personal expenses removed and genuine one-off items added back. In an owner-operated business this typically moves earnings 20 to 40 per cent.
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02
Weight into maintainable earnings
Three or more years are weighted to reflect what a new owner could sustain. A growing business is weighted toward recent years; one with a windfall year is weighted away from it. The weighting is stated and justified.
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03
Derive the capitalisation multiple
Start from the sector band, then adjust for owner dependence, recurring revenue, customer concentration, earnings trend and size. Each adjustment is listed rather than folded into a single unexplained figure.
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04
Bridge to equity value
Enterprise value less interest-bearing debt, plus surplus cash and non-operating assets, adjusted to a normalised working capital position — the number that actually reaches the shareholders.
Honest scope
When this method fits — and when it does not
Use it when
- The business has traded profitably for three or more years
- Earnings are reasonably consistent, or the trend is explainable
- The business is being sold, financed, divided or valued for tax
- Value clearly exceeds the net tangible asset base
Look elsewhere when
- The business is loss-making or newly established
- Earnings are about to change materially — a contract won or lost
- The business is asset-heavy with earnings below asset backing
- The entity is being wound up rather than sold as a going concern
Worked example: a professional services firm
Reported profit averages $610,000 over three years. The two principals draw $180,000 combined but market salaries for their roles total $320,000, so $140,000 comes off. A one-off software implementation of $70,000 is added back. Normalised maintainable earnings, weighted toward the most recent year, come to $545,000.
The professional services band is 2.5×–4.0×. This firm has four fee earners below the principals, 55 per cent of revenue on retainer and no client above 12 per cent — so 3.6× is supportable rather than the mid-point.
$1.96m enterprise value, before the debt and surplus asset bridge
Illustrative only. Every engagement is scoped to the specific business, its records and the purpose of the valuation.
What we need
Inputs for this valuation
Everything here goes to establishing what the business genuinely earns, independent of how the current owner chooses to be paid.
Open the document checklist →- Financial statements — three years Profit and loss, balance sheet and notes for each entity
- Income tax returns — three years As lodged, to reconcile against the statements
- Current year management accounts Year-to-date, ideally month by month
- Owner remuneration detail Salaries, drawings, superannuation and related-party payments
- One-off and non-recurring items Anything unusual in the last three years, with support
- Key contracts and customer list Revenue concentration and contract terms
Questions
Capitalisation of earnings, answered
Broader questions are on the full FAQ page.
Ask a valuerThey are the same calculation expressed two ways. A capitalisation rate of 25 per cent is identical to a 4.0× multiple — one is the inverse of the other. Australian SME practice usually quotes the multiple; formal reports often show both.
Three years as standard, sometimes four or five in cyclical sectors such as mining services or construction. Fewer than three years makes a maintainable earnings figure hard to defend, which is why very young businesses are usually valued by another method.
EBITDA for most SMEs, because it strips out financing and accounting choices. EBIT is used where depreciation reflects a genuine economic cost of maintaining the asset base — heavy transport and manufacturing, for example — and the report states which was applied and why.
The valuer derives it from market evidence, then adjusts for the specific risk profile of the business. It is not looked up in a table. The report sets out the starting band and every adjustment so the conclusion can be tested rather than accepted on trust.
Yes — it is the most commonly accepted method in both settings, provided the normalisation schedule is itemised, the earnings weighting is justified, the multiple is evidenced and the report carries a signed valuer’s declaration.
Reviewed by a Certified Practising Valuer
Reviewed by Jarrad Khoury, Director and Head of Valuations — Registered Valuer (QLD, Not Limited), Licensed Valuer (WA, Not Limited), CPV and CBV. Published by Business Valuations Brisbane, the business valuation division of Asset Valuations Group.
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