Using Earnings Forecasts To Value a Business

Expected earnings often serve as the foundation of business value. But estimating future performance is rarely straightforward, especially when the value conclusion is prepared for a transaction, estate planning or litigation. A business valuation professional must carefully evaluate which earnings forecast provides the most reliable basis for estimating value.

Forecasting Options

Depending on the valuation method applied, the term "earnings" may refer to cash flow, net income, earnings before interest, taxes, depreciation and amortization (EBITDA) or another type of economic benefit. It may come into play under both the income and market approaches.

When future earnings are used to derive business value, experts typically consider three primary sources:

1. Historical results. Financial statements and tax returns often provide the starting point for estimating future earnings. These records offer objective evidence of past performance, but they may require adjustments for discretionary expenses, nonrecurring items and unusual events.

However, historical results don't always reflect future expectations. For example, a business may be planning to enter a new market, discontinue an unprofitable product line or expand operations. These future changes wouldn't be included in financial statements, but they may affect value.

2. Management forecasts. Management is usually best positioned to understand a business's operations, customers, competitive environment and growth plans. Forecasts prepared for lenders, investors, internal planning or other purposes can provide useful insight into management's expectations. So valuation professionals often rely on management-prepared forecasts when estimating future earnings.

In most engagements, however, the valuation professional doesn't independently verify the accuracy of prospective financial information. Rather, the valuator evaluates whether management's assumptions appear reasonable based on the business's historical performance, current circumstances, and other information known or knowable on the valuation date.

3. Independent analyses. In some situations, valuation professionals develop their own earnings estimates based on company-specific and industry data. Independent analyses can help identify unsupported assumptions or potential management bias.

Often, the most reliable results come from a collaborative process in which management provides operational insight and the valuation professional evaluates the reasonableness of the underlying assumptions. Regardless of the approach, the valuation report should explain why a particular earnings forecast provides the best basis for estimating value.

Case in Point

The importance of selecting the right earnings forecast was demonstrated in a recent bankruptcy decision, In re Fall Creek One, LLC (677 B.R. 219, U.S. Bankruptcy Court, M.D. North Carolina, 2025). This case involved the valuation of an income-producing property that included rental cabins and newly developed glamping units. Both valuation experts relied on an income capitalization approach, and both used a 9% capitalization rate. However, their conclusions differed significantly because they used different estimates of future earnings.

The U.S. Bankruptcy Court found that the business's historical operating results weren't a reliable indicator of future performance because they were adversely affected by poor management, personnel changes and a hurricane. The court also identified weaknesses in both experts' estimates of future earnings, which were based on analyses of comparable-property data. One expert relied on properties that weren't truly comparable, while the other relied on data from the high end of a limited group of comparables.

Ultimately, the court relied on the debtor's own forecast of future earnings after the completion of planned improvements. The court found that forecast more persuasive than the experts' estimates because it reflected expected post-improvement operations and was supported by management's familiarity with the property's anticipated performance. Using the debtor's forecast and the agreed-upon capitalization rate, the court independently valued the business.

Professional Judgment Matters

A value conclusion is only as reliable as its underlying assumptions. When deciding which earnings forecast is most appropriate, valuation experts must apply professional skepticism, evaluate multiple sources of evidence and carefully document why a particular earnings forecast provides the most reasonable basis for value. Contact us for guidance on choosing the right path for your situation.