Income - Based Approach

Posted in Finance, Accounting and Economics Terms, Total Reads: 622
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Definition: Income - Based Approach

Income based approach is defined as an approach where the valuation of the company/organization is done based on the future ability of generation economic benefit to the shareholders/owners.


This approach is primarily based on going-concern concept where the company is expected to have infinitely long working period and not liquidate in near future. Under such circumstances, the economic benefit in terms of net cash flow etc is discounted, capitalized etc to provide the current firm value.


Income based approach is a broad approach which holds in itself a group of methodologies of business valuation like discounted cash flow, capitalization of earnings.


Example:

A company ABC is in its growth stage and is a potential investment for takeover. Hence, there is a necessity to value the firm and see how it is performing as on date. The net cash flows of firm of future years are estimated till it reaches a stable value which is generally termed the terminal value. These cash flows are discounted / capitalized by a rate which may be weighted average cost of capital and the firm’s value as on this date could be found out.


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