The determination of the value of the future income of an enterprise or firm is achieved by using the capitalization method, as well as the more complex, but also more accurate - discounting flows.
Here we consider in more detail the first of them - the method of capitalization of income. As a rule, it is used in situations where the firm’s income from the operation of certain objects to be evaluated is stably stable. In this sense, this method is the opposite of the discount method, since the latter is used in cases of income instability within the framework of the forecast time considered. For both cases, the most difficult issue is forecasting income for some future period. If the method of income capitalization is used, then only the first year is accepted for analysis (provided that an assumption is made that the same profitability will remain in subsequent years).
Together, both of these methods form the basis of the income approach, which makes it possible to accurately reflect the investors' ideas about the object that is being evaluated and, possibly, will serve as a source of income in the future . This approach is interconnected with others - comparative and costly, and some of their procedures and elements are included in the income analysis algorithm. The most sensitive drawback of such an analysis is that it is based on forecasting assumptions and, in the case of an unstable economic situation, can show unreliable results.
In its most general form, income capitalization is a process during which the magnitude and intensity of the income stream is transformed into a cost indicator (C). This is determined by either dividing or multiplying the magnitude of the flow (D) by the multiplier (M), which in economics is also called the capitalization coefficient (K). The general formula for this process is:
C = D / M (K), or C = D x M K).
The method of income capitalization is applied as follows. First, a certain analogue of the evaluated object is determined, as a rule, the basis of this choice is statistics on the commission of this type of transaction in the approximate period. That is, the success of the calculation depends on how much the selected analogue will adequately reflect the characteristics of the real object of evaluation. Then, the capitalization coefficient is calculated by the formula:
R = Y / V
In which R is the total coefficient, Y is the estimated (estimated for the analogue) net income, V is the estimated selling price of the analogue. Then the probable value of the real object is determined, for which the formula is used:
V = Y / R.
The method of capitalization of income can also be used in cases where it is necessary to evaluate the profitability of other assets taking into account the influence of other factors. For example, a method of capitalizing net income is widely used. It is most effective in predicting a stable income with a high degree of probability. Another example is the study of how capital income will be, using direct capitalization. Its main feature is that when determining the capitalization coefficient, information on prices and incomes is applied, which, of course, entails a change in the calculation formula. It takes the following form:
K = V / Y.
The fundamental principles of this method are widely used in the calculation of potential dividends, the effectiveness of the use of multipliers, the construction of possible projects for the growth models of the company, the study of borrowed and own capital, land, real estate and fixed assets. Modified versions of the method are the Ellwood method.