earnings may be distributed to owners and book value remain static even with growing company.
Determined by multiplying the average earnings or cash flow for a given period by a specified capitalization rate;
Adjustments to earnings are necessary for extraordinary items and excess compensation to owners;
Formula is usually based on a weighted average of cash flow to take into account trend of increased or decreased earnings;
Abnormal or non-recurring items such as changes in accounting methods, unusual gains or losses, or heavy retirement plan contributions must be considered.
The capitalization rate is the most important aspect of this approach. It is based on the rate of return a hypothetical investor would expect. Typically, the best guide to determining a cap rate is the sales price for comparable companies. This may be difficult to determine.
a.one alternative is the last agreed value unless there has been no agreement for given period of time (e.g.: 12 months), then use last value plus or minus change in Company’s net worth as fall-back to formula approach.
b.another possibility is a hybrid of the above methods, such as book value plus X times average cash flow for the prior five years.
1.The owner of a business typically does not have adequate information to provide realistic value.
Scca/99999.008/Doc#82/Speech for Lake County Estate Planning Council