What Does Income Approach Mean?
The income approach is a valuation method whereby the valuator quantifies the present value of future benefits associated with ownership of the equity interest or asset. The estimated future benefits that accrue to the owner are discounted or capitalized at a rate appropriate for the risks associated with those future benefits. Common sub-methods within the income approach include capitalized cash flows or capitalized earnings and the discounted cash flow approach.
Divestopedia Explains Income Approach
The income approach contemplates a continuing business operation with potential for maintaining cash flow from operations at a level that will provide a reasonable return on investment. This approach will capitalize or discount the estimated future maintainable after-tax cash flow from operations by a rate of return, which serves as a measure of the rate of return required by a prospective purchaser of the business reflecting the risk inherent in achieving the determined level of future cash flows.
The two biggest variables to determine value under this method are future cash flows and the risk of earning those future cash flows (measured by the discount or capitalization rate). A buisness owner that can manage and provide support for these two variables will be well on their way to maximizing value.