Capitalization of Income

Capitalization of Income

Capitalization of Income

Opposite to the Asset Valuation method, the Capitalization of Income appraisal method excludes the value of fixed assets such as machinery, and relies more on the intangibles. Obviously, this appraisal method is works better on non-asset rich companies such as retail and service businesses. Instead of deriving multiples of cash flow (Owner Benefit method), we rely upon a cap rate which is derived by various industry methodology. The build-up method uses statistical data from publicly traded companies. But usually cap rates are developed from Industry Rules of Thumb and market sales. Here are all the other factors used in arriving at a final cap rate:

  • Owner’s reason for selling
  • Length of time the company has been in business
  • Length of time current owner has owned the business
  • Degree of risk
  • Profitability
  • Location
  • Growth history
  • Competition
  • Entry barriers
  • Future potential for the industry
  • Customer base
  • Technology

Once the cap rate is formulated, the rest is easy in arriving at the value. Simply divide the cap rate into the SDE (Seller Discretionary Earnings)