For a business whose worth lies in the profit it keeps generating, the income approach turns that expected profit into a single figure in today's dollars.
The income approach values a Brisbane business at the present value of the earnings it can keep producing. One method takes a single year of normalised earnings and divides it by a capitalisation rate; the other, discounted cash flow, forecasts each year's cash flow, discounts it to today and adds a terminal value. Both rest on a discount rate assembled from risks that can be named.
A single year of normalised earnings, chosen because it reflects what the business can keep earning, is divided by a capitalisation rate (the discount rate less long-term growth). It suits a settled business whose recent years look alike, such as a Chermside general practice whose patient base and billing mix have held steady for several years.
Each year's cash flow is forecast separately and discounted to today, with a terminal value standing in for every year beyond the forecast. It suits a business whose coming years will look different from its past: a Newstead software company still building its subscriber base, a physiotherapy group about to open in North Lakes, or an engineering consultancy whose largest infrastructure contract finishes in year three.
A discount rate is not looked up; it is built one layer at a time, and every layer answers for a risk that can be named. The foundation is a risk-free rate taken from long-dated Australian Government bond yields (Source: RBA, Statistical Tables F2 Capital Market Yields). Above it the valuer adds an equity risk premium for owning a business rather than a bond, a size premium because a private company carries more risk than a listed one, an industry premium for the sector's cycles and regulation, and a company-specific loading for whatever sets this business apart from its peers: how concentrated its revenue is, how much rests on one person, how reliable its records are and where it operates.
Together the layers give a cost of equity. Where invested capital is being valued, that cost is blended with the after-tax cost of debt into a weighted average cost of capital. Deduct sustainable long-term growth and the result is the capitalisation rate; the earnings multiple is simply one divided by that rate.
Consider an illustrative general practice in Herston, close to the Royal Brisbane and Women's Hospital precinct, with six doctors billing through a service company. Normalisation replaces the principal's drawings with a market salary, resets the rent paid to the principal's family trust for the consulting rooms to a market rent, strips out a one-off insurance recovery after a burst pipe, and examines how the doctors' service arrangements are treated under the Payroll Tax Act 1971 (Qld) as administered by the Queensland Revenue Office, so that payroll tax is forecast on the current position rather than copied from past accounts. The company-specific loading then reflects that two doctors produce most of the billings and that the lease has three years left to run. That capitalisation rate, applied to the normalised earnings, gives an enterprise value range which the market approach can then test against sales of practices in Brisbane's inner north.
Businesses with a settled record of earnings: medical and dental practices from Herston and Woolloongabba to Chermside and Mount Gravatt, professional firms around Eagle Street and in Milton and Toowong, software and IT businesses in Fortitude Valley and Newstead, NDIS and aged care providers, broking books, and trade contractors whose service agreements roll over each year.
Earnings are never the only test. Wherever comparable sales exist the market approach is run alongside as a check, and the adjusted net asset figure is always worked out as the floor. The report then sets out why the income result carried the most weight for this business.