April is already upon us!
As highlighted in our first newsletter for 2026, we are excited to kick off our newsletter series focusing on Valuation insights.
Since July 2000, Munday Wilkinson has valued over 3,800 SMEs.
Valuations are typically done for purposes including Family Law, Shareholder Disputes, Mergers and Acquisitions, and Tax Restructuring Purposes.
In this issue, we focus on two of the most common income based valuations methods: the capitalisation of earnings method, and the discounted cash flow method.
The Capitalisation of Earnings Method (‘CME’)
The Capitalisation of Earnings method is one of the most widely used valuation approaches and is particularly well-suited for businesses with stable revenue and predictable cash flow. This method is not suitable however, for start-ups, businesses with erratic earning patterns or businesses that have large capital expenditure requirements in the near future.
A valuation based on this method requires a calculation of the expected future maintainable earnings from the business. The emphasis on maintainable earnings requires that there is a prospect of these earnings continuing into the future.
Generally, the past and present performance of the business entity will be examined, and adjusted to remove any extraneous or abnormal items that are not typical to the operations of the business. In addition, any income or expense that is not related to the core business (such as interest income) are also removed from the entity’s earnings because they have a different risk profile to core business operations.
Once the expected future maintainable earnings is derived, it is then multiplied by an appropriate price earnings multiple (or the inverse where it is divided by the capitalisation rate).
This rate adjusts for elements such as the inherent risk of business, as well as external factors such as the industry and the economy in general. This rate is subjective in the sense that it is intended to reflect appropriate risk factors associated with the particular entity being valued. Once this figure is determined and applied to the future earnings, it will reflect the expected rate of return from the business. These capitalised maintainable earnings are, essentially, the business value.
This value is then compared to the operating assets / liabilities to determine the value of any goodwill that exists in the business.
Tip: If the value of these operating assets is greater than the business value then no commercial goodwill exists and the business is valued on a net tangible operating assets basis.
It’s important to note that for family law and shareholder dispute purposes, you need to consider more than the business value and look deeper into assessing the equity value. ie. the value of the entire entity and not just the business. This equity value is derived by revaluing any non-operating assets / liabilities and adding these to the business value.
Some interesting points to note in relation to the CME method of valuation:
- While past and present earnings of a business serve as the primary guide, the level of future maintainable earnings will not always reflect these numbers. Internal (for example, product line changes) or external factors (such as the structure of the industry and the marketplace) may significantly impact calculations.
- Past accounting policies must also be considered, and prior results may sometimes have to be recast on a new basis.
- Results must also have regard to the potential impact of a change in ownership or management of the business. Any changes in management may impact on the clientele of the business, relationship with suppliers or the costs of finance.
The Discounted Cash Flow Method (‘DCF’)
The Discounted Cash Flow method has a strong theoretical basis. This method involves assessing the present value of future cash inflows and outflows, which are then “discounted” to determine what they are worth in “today’s” dollars.
This method is most appropriate for valuing a start-up or growth business, a business with a finite life and/or a business that experiences volatile cash flows.
While theoretically sound, (an asset is worth the sum of its future cash flows), this method can be difficult to apply in practice. It is not only difficult to accurately predict future events, but also the net present value is very sensitive to small changes in underlying assumptions.
Where the cash flows of a business is predicted to grow more or less uniformly in the foreseeable future, there is often not much point in departing from the CME method because the derived result will be much the same.
Aspects where the DCF method may present an edge in comparison to the CME method:
- The DCF method focuses on cash, which is how investors and bankers typically evaluate an investment;
- The DCF method is less susceptible to creative accounting or differing accounting procedures, thus is arguably a more “objective” calculation; and
- The DCF method places emphasis on the time value of money which is important in evaluating investments over a number of years.
Anything Spark Your Interest?
We are well aware that this is a highlights tour of income-based valuation methods, with plenty of details left unexplored.
If any particular aspect mentioned above sparks your curiosity, we’d love to continue the conversation over coffee or a dedicated session at your office.
Winners of the Lucky Door Prize!
We were proud to sponsor the Family Law Conference on Property Matters, Skills and Ethics recently held by Legalwise, and take this opportunity to congratulate the winners of the Lucky Door Prize.
Congratulations to Allana Goldsworthy, Barrister at Foley’s List who receives a voucher for dinner for two at her restaurant of choice. The Runner up prize goes to Effie Gidakos of Choice Legal, who received a Cheese & Wine hamper. We hope you enjoy your prizes!
Our Accredited Specialists
Victoria Wheeler – Director with over 20 years’ experience in accounting, business services and taxation. She is recognised as a Forensic Accounting Specialist by CA ANZ and has appeared as an Expert Witness in the Federal Circuit Court of Australia and County Court of Victoria.
Joshua Wheeler – Director with over 17 years’ experience in commercial and professional accounting services. He has appeared as an Expert Witness in the County Court of Victoria, and has participated in conferences / mediations with legal representatives and other experts. He was a presenter at the inaugural SV Partners Accounting Forum, has presented with Legalwise Australia, and regularly presents to law firms on Business Valuations for Family Law matters.
Both Victoria and Joshua are recognised as Business Valuation Specialists by CA ANZ.
As always you can reach out at any time on (03) 9816 9122 or email us at advice@mwforensic.com.au.
Regards,
The MW Forensic Team
Disclaimer: Although every care has been taken in preparing “MW Insights”, no responsibility is accepted by Munday Wilkinson Pty Ltd for errors or omissions. Professional advice should be sought before applying the information to particular circumstances.
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Munday Wilkinson, trading as MW Forensic, is a boutique business valuation and forensic accounting firm established in June 2000. We offer the legal profession, and others, a quality, personalised, time efficient and cost-effective service