Why this is Australia's default method
Capitalisation of future maintainable earnings — usually shortened to FME or CME — answers a simple question: what level of profit can this business sustainably generate, and what would a purchaser pay for each dollar of that profit? The method has two judgment inputs. The first is the maintainable earnings figure, built from normalised historical performance. The second is the capitalisation multiple, which converts that figure into a value by reflecting the risk of the earnings continuing and their prospects for growth. Multiply one by the other, adjust for debt and surplus assets, and you have an equity value. FME is the default for Australian private companies because most of them fit its assumptions: established, profitable trading businesses without the reliable long-term forecasts that discounted cash flow requires. It is consistent with market value under IVS 104 and the willing-but-not-anxious purchaser principle from Spencer v Commonwealth (1907), and the ATO's market valuation for tax purposes guidance recognises capitalisation of earnings as an accepted approach for established profitable businesses. What the guidance does not do is make any particular application of the method acceptable — that depends entirely on how the two judgment inputs are evidenced.
What 'maintainable' actually means
Maintainable earnings is not last year's profit, not a simple average of the last three years, and not the budget. It is the level of earnings a hypothetical purchaser could reasonably expect the business to sustain into the future, judged from demonstrated performance. In practice the valuer works from three to five years of normalised results and asks what they show. A stable history: the recent normalised level is usually maintainable. Consistent growth: the most recent year, or a figure modestly above it, may be supportable — with reasoning about whether the growth drivers persist. A declining trend: the most recent year may be the ceiling rather than the midpoint, and the report must explain why the decline does or does not continue. A volatile history: a weighted average may be appropriate, with the weighting justified rather than mechanical. The word maintainable carries the entire judgment. Two valuers can look at the same P&L and adopt different maintainable figures — which is why the reasoning, not just the number, is what a reviewer reads.
Choosing the earnings base: EBITDA, EBIT or NPAT
The maintainable figure has to be expressed in some earnings measure, and the choice matters less than the consistency. EBITDA is the most common base for Australian SMEs because private transaction evidence is usually quoted that way. EBIT is more appropriate where the business is capital-intensive — depreciation is a real economic cost for a transport or manufacturing business, and ignoring it flatters the earnings. NPAT is more common for larger companies and for interests valued on price-earnings evidence. The discipline is that the earnings base and the multiple must match: an EBITDA figure capitalised at a multiple derived from EBIT transactions overstates value, and the mismatch is one of the most common defects in thin valuations. A competent report states the base, states why, and applies multiple evidence expressed on the same base.
Normalisation, step by step
Normalisation converts the reported profit — prepared for tax and accounting purposes — into the profit a purchaser would actually receive. Every adjustment moves in whichever direction the evidence points; normalisation is not a synonym for add-backs that increase the figure. The standard sequence:
- ·Owner remuneration to market: replace what the owners actually paid themselves with the market salary for the roles they perform. Where an owner underpays themselves, the adjustment reduces earnings; where they overpay, it increases them.
- ·Related-party items to arm's length: rent paid to a related landlord entity restated to market rent (supported by an appraisal or comparable leases); management fees and intercompany charges restated to commercial terms or removed.
- ·One-off items removed: gains on asset sales, insurance recoveries, litigation settlements, restructure costs, one-off disruptions — anything a purchaser would not expect to recur, in either direction.
- ·Private and discretionary expenses: personal vehicle, travel and family costs run through the business are added back only where documented. An add-back without evidence is an assertion, not an adjustment.
- ·Accounting consistency: revenue recognition, stock valuation and provisioning applied on the same basis across the years being compared, so the trend is real rather than a policy artefact.
How the capitalisation multiple is selected and evidenced
The multiple is the inverse of a capitalisation rate — conceptually, the purchaser's required rate of return less sustainable growth. In practice, for private companies, it is evidenced rather than derived: comparable private-company transaction data, business-broker transaction evidence in the relevant size band, listed-company multiples adjusted for size and marketability, and a reasoned build-up of the risks specific to the entity. The entity-specific factors move the multiple within the comparable range: customer concentration, key-person dependency, contract quality and duration, competitive position, industry outlook, and the quality of the earnings history itself. Under IVS and APES 225 the selection must be documented as reasoning, not asserted as a number — a report that says a multiple of 4.0x has been adopted, without explaining why 4.0x rather than 3.0x or 5.0x, is exactly the weak point a reviewer presses. The evidence trail behind the multiple is usually where a valuation file either holds or fails.
A worked example: raw P&L to concluded value
Take an established services business. Reported EBITDA for the most recent year is $700,000. Normalisation: the two working owners paid themselves $100,000 in total against a market salary cost of $190,000 for the roles they fill (deduct $90,000); premises are owned by a related family trust charging $50,000 against a market rent of $85,000 (deduct $35,000); a one-off gain on the sale of plant of $40,000 is removed; a non-recurring legal settlement cost of $55,000 is added back; documented private expenses of $30,000 are added back. Normalised EBITDA: $620,000. The prior two years, normalised on the same basis, show $540,000 and $600,000 — a steady trend that supports adopting maintainable EBITDA of $600,000 rather than the most recent peak. Comparable transaction evidence for services businesses in this size band supports EBITDA multiples of roughly 3.0x to 4.0x; the entity's customer concentration and owner dependency sit against its long contract base, supporting a mid-range 3.5x. Enterprise value: $600,000 × 3.5 = $2.1m. Deduct debt of $200,000 and add surplus cash of $100,000 not required for operations: equity value $2.0m. Sensitivity across a 3.25x–3.75x multiple band gives an equity range of roughly $1.85m to $2.15m — and the concluded position within that range is the one the comparable evidence and risk analysis best defend.
When FME is not the right method
The ATO's guidance and the courts share the same expectation: the methodology must fit the asset. FME assumes an established, profitable business whose future looks broadly like its recent past. Where that assumption fails, another method leads. Loss-making or early-stage businesses cannot capitalise earnings that do not exist — discounted cash flow (where credible forecasts exist) or net assets applies. Businesses in demonstrable transition — a signed contract that materially changes revenue, a genuine growth phase, a finite-life licence or agreement — call for DCF, because capitalising history mismeasures a future that is known to differ from it. Asset-holding entities — investment companies, property-holding structures, entities whose value sits in what they own rather than what they earn — are valued on net assets, with the assets themselves restated to market value. And even where FME leads, a net asset cross-check is expected: where net assets exceed the capitalised earnings value, the report must deal with why, because a business worth more broken up than trading changes the conclusion. Applying FME to a business it does not fit is the methodology error reviewers and courts identify first.
What the working file needs — and where we fit
An FME conclusion is only as strong as its file: the normalisation schedule with supporting evidence for every adjustment, the market salary evidence, the market rent appraisal, the comparable transaction data behind the multiple, the sensitivity analysis, and the reasoning that connects them into a single most supportable position. Prismi's Comprehensive engagement (from $3,995 + GST) applies capitalised maintainable earnings with a second methodology as cross-check, normalised earnings documented line by line, and senior-reviewer sign-off; the Defensible Valuation File (from $8,995 + GST) adds the full evidence pack for matters likely to be reviewed. Reports are prepared with ATO market valuation expectations in mind and documented so the position is defensible if reviewed — not 'ATO-approved', because no such status exists. And a boundary worth stating plainly: we prepare the independent valuation; how the value is applied to CGT, Division 7A or restructure questions is your accountant's or lawyer's domain, not ours.