Capitalized cash flow method (capitalization of earnings)

A valuator picks one period of expected cash flow or earnings, normalizes it, and divides it by a capitalization rate. CBV Institute defines its capitalization of economic income method this way. A buyer meets it in a valuation report or in a seller’s account of how an asking price was reached. See how to get a business valuation before selling.

When it is used

BDC says capitalized cash flow is used when cash flow is expected to remain stable in future years, and discounted cash flow when it is expected to fluctuate substantially. The CRA’s policy statement on business equity valuations says risk in a going concern value is expressed as the capitalization rate, and ties it to factors such as the stability or irregularity of the maintainable level of earnings or cash flows. CBV Institute says the capitalization rate is generally a discount rate less a long-term growth rate. See capitalization rate.

What to ask

• Which period of cash flow was used, and how was it normalized?
• What capitalization rate was applied, and what supports it?
• Why was this method chosen rather than discounted cash flow?
• Is this a valuation report by a qualified valuator, or the seller’s own calculation?