Don’t Trust the Number: How to Read and Challenge a Valuation Report

You're negotiating to sell your business. The buyer's valuer says it's worth $2 million. Your accountant says $3 million. Both used the same method, the same financial records, and both valuers are qualified professionals. So why the $1 million gap?

Most business valuations for SMEs in Australia use the same core method: Capitalisation of Future Maintainable Earnings (CFME). You see it expressed as "4 × EBITDA" or "5 × normalised earnings" in sale negotiations, shareholder disputes and family law matters.

The formula is quite simple: Future Maintainable Earnings × Multiple = Business Value.

However, in reality, every CFME valuation is built on layers of judgement calls about what earnings are "maintainable" and what is an appropriate multiple that reflects risks and growth. Small shifts in either component can move value by 30–50% or more, all within the bounds of "acceptable" professional practice.

This article explains how CFME valuations really work, where the assumptions sit, and how you can assess whether a valuation report reflects a robust valuation or just a sophisticated guess.

What CFME Actually Is

CFME is a compressed discounted cash flow (DCF) method. Instead of forecasting every future year, you take one representative level of earnings and "capitalise" it using a rate (or multiple) that reflects the business' risk profile and expected long-term growth.

The mechanics:

• Start with historical financial results (typically 3–5 years)
• Normalise those results to arrive at Future Maintainable Earnings
• Apply a capitalisation rate or multiple to convert earnings into value
• Adjust for surplus assets, debt and other items to arrive at equity value.

This method is common for SME valuations because it is practical, widely understood and relies on relatively few inputs compared to full DCF models.

But those "few inputs" are where most of the value and most of the disputes arise from.

Step 1: Future Maintainable Earnings – Where People Fudge the "E"

Future Maintainable Earnings (FME) is not last year's profit. It is a judgement about what level of earnings the business can sustain going forward, under competent management and in normal market conditions.

What Should Happen

A proper FME calculation starts from several years of historical results and applies a series of normalisations:

• Owner wages: Adjust for commercial market salaries if owners are under-paying (or over-paying) themselves, or not recording wages at all
• Personal expenses: Remove private vehicle costs, family travel, home office costs run through the business
• One-off items: Strip out unusual gains/losses, COVID support, subsidies, insurance claims, restructuring costs
• Related-party transactions: Normalise rents, management fees and equipment hire charged by related entities to arm's length rates
• Known changes: Factor in lost or gained contracts, capacity constraints, key staff departures, step-changes in input costs or regulatory requirements

The valuer then selects or weighs the normalised results to arrive at a single FME figure that represents a sustainable, recurring level of earnings.

Where It Goes Wrong

Common problems in SME valuations include:

• Cherry-picking the best year: Using the latest or highest year as "maintainable" without testing whether it is repeatable
• Missing owner salary normalisation: Ignoring that the owner draws $60k when a commercial manager would cost $120k, artificially inflating earnings
• Leaving personal expenses in: Accepting tax accounts at face value without stripping private costs
• Double-counting growth: Quietly assuming growth inside the "maintainable" earnings number and then applying a high multiple that also reflects growth expectations
• Ignoring customer or key-person concentration: Not adjusting earnings downward when 40% of revenue comes from one client or one irreplaceable individual

Numeric Example – Owner Wage Adjustment

💡 Key Insight: In SME valuations, normalising owner wages is often the single largest value adjustment, and the one most commonly missed.

Consider a small electrical contractor:

• Reported net profit (FY25) 180,000

• Less: Commercial owner salary adjustment (100,000)

• Add back: Personal vehicle costs 12,000

• Adjusted maintainable earnings 92,000

At a 4× multiple:

• Unadjusted value: $180,000 × 4 = $720,000
• Adjusted value: $92,000 × 4 = $368,000

A single normalisation (commercial owner wage) has reduced the indicated value by 49%.

This is why the "E" in CFME matters more than any formula.

Step 2: The Multiple – The Quiet Value Lever

The multiple (or its inverse, the capitalisation rate) is where risk and growth expectations are translated into value.

How It Works

The capitalisation rate reflects the required rate of return for an investor, adjusted for the business' specific risk profile and expected growth. The multiple is simply the inverse:

• Capitalisation rate 20% = 5× multiple
• Capitalisation rate 25% = 4× multiple
• Capitalisation rate 33% = 3× multiple

Higher risk and lower growth → higher cap rate → lower multiple

Lower risk and higher growth → lower cap rate → higher multiple

Sensitivity to the Multiple

Small businesses typically trade between 2× and 5× maintainable earnings, depending on size, industry, margins, customer concentration, management depth and growth prospects.

Moving from a 3× to a 5× multiple increases value by 67% for the same earnings.

Where It Goes Wrong

Common issues with multiples in SME valuations:

• Round-number multiples without evidence: Applying "4× because that's market" without linking to actual deal data or listed peer analysis
• Double-counting growth: Building optimistic growth into FME and then applying a high multiple that already assumes growth
• Ignoring specific risks: Using a generic multiple without adjusting for customer concentration, key-person dependence, working capital intensity or geographic concentration
• Stale comparables: Relying on transaction data from different market conditions (e.g. pre-COVID deals in 2026 valuations)

Numeric Example – Multiple Sensitivity

💡 Key Insight: The gap between a 3× and 5× multiple is often the difference between a deal proceeding or collapsing.

Using the electrical contractor from Step 1, with adjusted FME of $92,000:

• Multiple 3.0× =276,000 valuation (baseline)
• Multiple 3.5× =322,000 valuation +17%
• Multiple 4.0× =368,000 valuation +33%
• Multiple 4.5× =414,000 valuation +50%
• Multiple 5.0× =460,000 valuation +67%

Moving from 3× to 5× adds $184,000 to the business value for the same underlying earnings.

This is why the multiple is the single most powerful lever in any CFME valuation, and why you should always ask: "Where did this multiple come from, and what deal data supports it?".

Step 3: The Final Trap – Confusing Business Value with Equity Value

CFME typically produces an enterprise value, the value of the business operations. To arrive at the value of the shares (equity value), you need to adjust for non-operating items:

• Start with: Business value (FME × Multiple)
• Add: Surplus cash, investments, related party loans, non-core assets (property, equipment not used in operations)
• Subtract: Interest-bearing debt, lease liabilities, leave liabilities, related-party borrowings
• Result: Equity value

Further adjustments for control premiums, minority discounts or lack-of-marketability discounts can be applied depending on the interest being valued.

Where It Goes Wrong

• Shareholder loans at face value: Treating director loans as $200k assets when recoverability is uncertain and market value may be $50k or nil
• Ignoring surplus assets: Not adding back the $150k of excess cash sitting in the business account
• Confusing enterprise and equity value in negotiations: Seller quotes "business worth $500k" (enterprise) but buyer calculates equity value after $200k debt as $300k, leading to a $200k gap in expectations

A clear reconciliation from enterprise value to equity value, with each adjustment explained and valued separately, is essential in any CFME report.

Six Questions to Stress-Test Any Valuation Report"

Use this checklist whenever you receive a CFME-based valuation report:

1. Multiple years, not one: Have future maintainable earnings been built from several years of results with clear, line-by-line normalisations, or is it just last year's profit rebadged?
2. Owner wages and personal costs: Have owner salaries, personal expenses and related-party charges been normalised to commercial arm's length levels with evidence (market salary surveys, commercial lease comparisons), not just assertions?
3. No double-counting of growth: Is there any double-counting—optimistic earnings growth already inside "maintainable" earnings, and then a high multiple that also assumes growth?
4. Multiple tied to evidence: Is the multiple or capitalisation rate clearly linked to market transaction data, listed peer analysis or published risk premiums, rather than being a round number with no support?
5. Enterprise to equity bridge: Does the report clearly reconcile from business value to equity value, showing surplus assets, debt and other adjustments separately and transparently?
6. Sensitivity check: If you flex the key assumptions, e.g. earnings down 10%, multiple down from 4× to 3×, does the commercial conclusion still hold?

If the report fails more than one of these tests, treat the conclusion as indicative at best.

And Who Is Right?

In our opening example, there was a million dollar gap between two valuations. Which one was “right”? $2 million or $3 million?

Quite possibly both.

A valuation is, at its core, a projection of future cash flows, discounted back to today. It is not a fact; it is a structured view of the future.

Change the expectations, and you change the value.

Small shifts in assumptions about risk, growth, margins, customer concentration or management depth can all produce different, but still technically defensible, answers. That is why two qualified valuers can look at the same business and land on very different numbers.

This is also why it is so important to:

• understand which assumptions drive the result
• test whether those assumptions are realistic for this business
• be able to justify them in front of a buyer, a court, or the ATO

If you do not understand the assumptions, you do not really understand the valuation.

What to Do Next

Don't Accept a Valuation at Face Value

At WCT Advisory, we treat CFME valuations as decision tools, not untouchable opinions. If you're facing a sale negotiation, shareholder dispute, family law matter, or restructuring and the valuation doesn't pass the smell test, we can help you:

• Unpack the assumptions and test them against commercial reality
• Provide an independent review or rebuttal opinion
• Model the commercial impact of flexing key assumptions
• Support negotiations or litigation with evidence-based analysis

A valuation is only as good as the assumptions underneath it. Knowing which assumptions to challenge, and how, is what turns a thick report into actionable advice.