Where the value of a business lies in the profit it will keep producing, the income approach converts those future earnings into a price today.
Under the income approach, a Melbourne business is worth the present value of the earnings it can sustain. Capitalisation of future maintainable earnings divides one normalised earnings figure by a capitalisation rate; discounted cash flow projects each year's cash flow, discounts it back to today and adds a terminal value. Both depend on a discount rate built from identifiable risks.
One year of normalised earnings, chosen to represent what the business can sustain, is divided by a capitalisation rate (the discount rate less long-term growth). It fits a mature practice or firm whose recent years look alike, such as an established general practice in Box Hill where patient numbers and billing mix have settled.
Cash flow is projected one year at a time, each year is discounted back to today, and a terminal value captures everything beyond the forecast. It fits a business whose next few years will not resemble its last few: a Cremorne software firm still scaling, a clinic opening a second site, or a contractor whose largest contract expires in year three.
No discount rate is read from a table. It is assembled layer by layer, and each layer pays for a risk you can name. The base is a risk-free rate drawn from long-dated Australian Government bond yields (Source: RBA, Statistical Tables F2 Capital Market Yields). On top sit an equity risk premium for holding a business instead of a bond, a size premium because a private company is riskier than a listed one, an industry premium for the sector's own cycles and regulation, and a company-specific loading for the things that make this business riskier or safer than its peers: how many customers make up most of the revenue, how much depends on one person, how good the records are, and where it trades.
Adding the layers gives a cost of equity. If the valuation is done on invested capital, that is blended with the after-tax cost of debt to give a weighted average cost of capital. Subtract sustainable long-term growth from the discount rate and you have the capitalisation rate, which is simply the inverse of the earnings multiple.
Take an illustrative general practice in Parkville, near the biomedical precinct, with five doctors billing through a service entity. Normalisation resets the principal's drawings to a market salary, restates the rent paid to the principal's family trust to arm's length, removes a one-off insurance recovery, and reviews how the doctors' contractor arrangements are treated under the Payroll Tax Act 2007 (Vic), including whether the Victorian exemption for bulk-billed GP consultations administered by the SRO applies. The company-specific loading then reflects that two doctors generate most of the billings and that the lease has four years to run. The resulting capitalisation rate, applied to normalised earnings, gives an enterprise value range that the market approach can then cross-check against practice sales in the eastern suburbs.
Trading businesses with a settled earnings history: medical and dental practices from Parkville to Glen Waverley, professional firms on Collins Street and in the suburbs, recurring-revenue software in Cremorne, NDIS and aged care providers, broking books, and trade contractors whose maintenance contracts renew each year.
None of these is valued on earnings alone. The market approach is run as a cross-check wherever comparable sales exist, and the adjusted net asset figure is always calculated as the floor. The report then explains in words why the income result was given the most weight.