A common method of valuing a business in Australia is the Future Maintainable Earnings (FME) method.
FME is often referred to as a “back of the envelope” valuation technique and involves determining a sustainable level of earnings of a business and capitalising it with an appropriate market multiple reflecting the risk of those cashflows. The FME methodology is widely used by
valuation professionals, accounting firms and consulting firms across Australia.
Earlier this year the International Valuation Standards Council (IVSC) issued their updated valuation standards. It is clear from the released standard, the FME approach is not a recognised valuation methodology. The IVS refer to two key valuation approaches frequently applied:
- The Income Approach
- The Market Approach
The FME method doesn’t quite fit into either of these buckets.
The Income Approach requires a capitalisation rate or discount rate to convert future cash flows to a present value figure. However, the FME method uses a multiple rather than a discount rate, and that multiple is derived from market data (similar to the Market Approach).
The Market Approach uses past transactions of similar type to determine an appropriate market multiple. These multiples are based on selected level of earnings in reference to a specific
time period or year – not FME. There is no unit of comparison to previous transactions – market multiples would be different if FME was used in all transactions.
So why has this method been one of the most common methods used in Australia then?
Care should be taken when preparing valuations that appropriate and compliant methodologies are adopted by the valuer.