The 2025 updated International Valuation Standards were issued earlier in the year and, as ever, the FME business valuation method is no where to be seen.*
What has happened to the beloved FME business valuation method? Has it expired, passed on, ceased to be?
Why no FME in the IVS?
The International Valuation Standards refer to two key valuation approaches frequently applied in valuing businesses [1]:
- The Income Approach (IVS 200 paragraph 60.01)
- The Market Approach (IVS 200 paragraph 50.01)
The FME method does not seem to fit either valuation approach.
What is FME?
FME stands for Future Maintainable Earnings and according to a basic google search, FME ranks as one of the most popular methods of valuing a business in Australia.
But what is the FME method? I looked to guidance from some of our esteemed colleagues overseas: Hitchner, Mercer, Pratt and Trugman. They all talk readily about the Future and Earnings, but no one talks of FME. Is FME a uniquely Australian phenomenon?
According to google, FME is variously described as “a simplified version of DCF”, and involves “capitalising the earnings of the business at an appropriate multiple”, where the FME is “normalised expected future earnings”.
Not an income approach?
Per the standards an Income Approach requires either (IVS 200, paragraph 60.05):
- a capitalisation rate when capitalising income, or
- cash flow and a discount rate when discounting cash flows.
FME seems to fit nicely in the first category. The capitalisation of future earnings.
According to the standards, all valuation methods under the Income Approach are essentially based on discounting cash flows to present values (IVS 103, paragraph A20.01).
Where the discount rate must be consistent with the cash flow and common methods to establish the discount rate include the capital asset pricing model, the weighted-average-cost-of-capital, inferred rates and a build up method (IVS 103, paragraph A 20.31). In capitalisation methods, growth is also reflected in the capitalisation rate (IVS 200, paragraph 60.07).
But the FME method appears to use a “capitalisation” multiple (typically 3!) and not a capitalisation rate. Where does that “capitalisation” multiple come from?
A multiple of 3 would seem to imply a capitalisation rate of 33.33% (1/3), but how is the discount rate (and the growth rate) derived to justify a capitalisation rate of 33.33%? Does it comprise of a discount rate derived, per the standards, from the capital asset pricing model, the weighted-average-cost-of-capital, inferred rates and a build up method or is it simply a multiple based on observed transactions?
If the “capitalisation” multiple is based on observable market transactions then it appears that FME might better be described as a Market Approach method.
Not a Market Approach?
“Multiple” is not a term used in the Income Approach, but “multiple” does appear (multiple times!) under the Market Approach.
Under the Market Approach value is attributed by comparing the subject business with similar businesses for which price information is available, through transactions and publicly-traded companies (IVS 103, paragraph 20.01). The units of comparison (the valuation metrics) are multiples, and these include revenue multiples and EBITDA multiples (FME multiples are not mentioned!) (IVS 103, paragraph A10.04).
Under the Market Approach, adjustments are made to the valuation metrics to reflect differences between the subject business and the comparable business and the metric is then applied to the subject business (IVS 103, paragraphs A10.16 (d) and (e)).
The key is consistency, for example, a comparable business EBITDA multiple for the last twelve months would be applied to the subject business EBITDA also in the last twelve months.
Transactions and publicly-traded companies usually report on historical and forecast revenue and EBITDA, allowing valuation metrics to be derived. However, transactions and publicly-traded companies do not report on FME! FME as in “normalised expected future earnings” is not a unit of comparison.
Pushing up the daisies?
FME appears on the surface to be a capitalisation of earnings method under an Income Approach. However, it is only an Income Approach method if the capitalisation rate is derived from first principals, for example, the capital asset pricing model, the weighted-average-cost-of-capital, inferred rates and a build up method.
If the FME method relies instead on observed market-based multiples, then the method falls into the Market Approach. The problem is FME in itself is not a unit of comparison.
FME RIP?
Simon Cook
Simon specialises in wrestling with and attempting to pacify often complex valuation problems. He is a Business Valuation Specialist with Chartered Accountants Australia and New Zealand (CA ANZ). He chairs the CA ANZ Business Valuation group for Queensland, is a member of the CA ANZ Trans-Tasman Business Valuation Committee and likes running long distances in muddy hills!
* This is slightly misleading marketing hyperbole, because the standards do not attempt to provide an exhaustive list of all valuation methods.
[1] The International Valuation Standards also refer to the cost approach, which “is rarely applicable in the valuation of businesses”, IVS 200, paragraph 70.01.
