The Income Approach Explained Simply

What Is the Income Approach?

The income approach is a business valuation method that determines a company’s value based on the income it is expected to generate in the future. In simple terms, it answers the question: How much is this business worth based on its ability to make money over time?

This method is especially useful when a business has stable, predictable earnings and a clear path for continued operation or growth.

Why the Income Approach Matters to Small Business Owners

Whether you're planning to sell your company, bring in investors, or apply for an SBA loan, the income approach gives buyers and lenders a logical way to assess future earning potential. It’s not just about what your business made last year—it’s about what it’s likely to make going forward, and how reliable those projections are.

This makes the income approach one of the most respected and commonly used valuation methods in small business finance.

Common Examples and Use Cases

Here are a few situations where the income approach is commonly applied:

• Selling a business with strong recurring revenue or contracts

• Valuing a professional practice, such as a law firm, medical clinic, or consulting agency

• Supporting loan applications, especially for SBA 7(a) or 504 financing

• Divorce, buyouts, or partner disputes, where income must be projected to determine fair market value

There are two main techniques within this approach:

• Capitalization of Earnings Method – used when earnings are stable

• Discounted Cash Flow (DCF) Method – used when earnings are expected to vary over time

Related Terms and Misconceptions

• Related Terms: Discount rate, cash flow projections, EBITDA, seller’s discretionary earnings (SDE)

  
  

• Common Misconceptions:

  
  

  • “The income approach only works for big companies.” False—it's often ideal for small, cash-generating businesses.

  • “Valuation is based only on past performance.” Not quite—the income approach emphasizes the future.

This method is rooted in the principle that an asset’s value is equal to the present value of the expected future benefits.

Tips for Applying the Income Approach in Your Business

To prepare your business for an income-based valuation:

• Track and document recurring revenue (subscriptions, service contracts, etc.)

• Maintain clean and consistent financial statements—your projections are only as credible as your records

• Control expenses and improve margins—a higher net income means a higher valuation

• Use professional help—a Certified Valuation Analyst (CVA) can apply the method properly and defend the results

Final Thoughts

The income approach turns your business’s future into a dollar amount today. It’s a powerful way to show value—especially if you’ve built something that generates consistent income.