Valuation of business by income approach: what should be practically looked for

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The best way to determine the value of most companies is to use income approach. However, when determining the enterprise value basing on future revenue, it is important to take into account some details. For instance, in order to determine the time of the cash flow forecast, choose the method of calculating cash flow and determine the terminal value of the company. When finished with calculating, check whether everything was taken into account.

The main point of the income approach is that the enterprise value is determined on the basis of future revenues that it can bring to its owner. Regarding specific calculations, there are two main methods to operate information on upcoming business income: discounting and capitalization of cash flows. Let’s examine discounting thoroughly; it is more often applied for practical valuation of operating enterprises. Discounting presupposes the following actions to be done:

  • Identification of the forecast period
  • Preparation of the forecast of cash flow period
  • Calculation of terminal cost (the future business cost at the end  of the forecast period) ·
  • Calculation of business value - the sum of the discounted cash flows over the projection period and the terminal value ·       
  •   Making final adjustments

Deputy Director of Valuation Department of FBK Aleksandr Matyushin reveals in details what an income approach is.

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