The National Directory of Certified Public Accountants

Ask A CPA - Buying & Selling a Business

Within The Many Business Valuation Methods , What Is The Discounted Future Earnings Method ?

The discounted future earnings method calculates the value today (discounted for time) of the businesses earnings in the future. The evaluator must forecast revenues, expenses, profits and cash flows. The appraiser must carefully analyze all factors and uncertainties that can impact a business’s ability to generate future earnings. Risk assessment is the most important aspect of the analysis. The discount rate, which is a percentage number usually between 15% and 100%, quantifies risk. Usually, the applicable discount rate correlates directly with yields on publicly available securities such as treasury bills, shares of publicly held companies or corporate bonds. The higher the discount rate the riskier the business. For small businesses, such as restaurants, liquor stores, convenience stores, bars or cleaners, a variety of other methods, ratios and formulas are used. These methods are unique to the circumstances and usually cannot be supported by straight forward theoretical documentation. Speak to your local CPA or business broker for more information about valuing a business and on your pending purchase or sale.

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