What sum of money can you, as the buyer, reasonably expect to generate on an ongoing basis so long as the firm’s future is representative of past historical financial data?
This general rule of thumb may have some use in obtaining a quick-and-dirty estimate from the outset, but that is all it is. There’s a reason for that: Everyone’s motivation for buying a business is a little bit different, and there’s too many potential factors at play for this to be a meaningful metric.
In order to glean a more accurate assessment, you’ll need to go a bit deeper. It’s crucial to view the upcoming transaction from the perspective of the total benefits a buyer receives. This is a smart way to look at it and it will help you gain perspective as you prepare for negotiations.
Do take note that income capitalization typically only applies to large businesses and in many cases, it’s much too broad of an indicator anyway for determining the current value of a small business.