One of the “Dirty Little Valuation Secrets” Bob Duffy, CPA/ABV, CFA, ASA (Grant Thornton, Seattle, WA) shared with AICPA/AAML Las Vegas attendees was his concern about the excess earnings method. “This method is like a guitar” Duffy described. “A guitar has six strings, the excess earnings method basically has six inputs and you can get it to create any ‘song’ you want it to sing.” He showed an example of a huge swing in valuation conclusions with a $50K reasonable compensation adjustment and a $50K difference in sustainable income inputs.
Maybe the method was flawed from the beginning – Duffy reminded appraisers and lawyers at the conference that it was developed during prohibition when distillers had to be paid the value of intangibles. For all its faults, however, Duffy still considers the excess earnings method when valuing professional practices because there really is “no better model” for accounting for the low-risk receivables and high-risk intangibles.