Capitalized Excess Earnings

What It Means

Capitalized Excess Earnings method determines the business value by summing the net tangible value of the business assets with the capitalized value of the “excess” earnings. A typical procedure to establish the business value with the method is:

• Start with the business net tangible assets, obtained from its recast financial statements by subtracting adjusted liabilities from the tangible assets.
• Estimate the business earnings attributable to the net tangible assets. This is done by multiplying the net tangible assets by a reasonable rate of return, expressed as a percentage.
• Determine the excess earnings as the difference between the total business earnings and those attributable to the net tangible assets. These excess earnings reflect the business goodwill.
• Capitalize the excess earnings by dividing their value by an appropriate capitalization rate.
• Add the capitalized excess earnings value to the value of the business net tangible assets, to establish the overall business value.

Capitalized Excess Earnings method is often called the Treasury Method because it was first introduced by the US Treasury Department in the 1920s to value business goodwill. It is described in the Appeals and Review Memorandum Number 34. Widely adopted by the professional appraisal community, this method has been further clarified in the US Internal Revenue Service Ruling 68-609.