Premium Profit Method explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
Free cash flow, not EBIT, is what gets differenced — and the working capital line moves in opposite directions in the two scenarios.
Cash flows with the agreement
| Rs. lakhs | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 |
|---|---|---|---|---|---|---|
| EBIT | 100 | 116 | 130 | 140 | 150 | 160 |
| Less: Income tax @ 35% | 35 | 41 | 46 | 49 | 53 | 56 |
| Net income | 65 | 75 | 84 | 91 | 97 | 104 |
| Add: Depreciation | 4 | 4 | 4 | 4 | 3 | 3 |
| Less: CAPEX | 20 | 20 | 15 | 10 | 10 | 8 |
| Less: Increase in WC | 9 | 8 | 7 | 6 | 5 | 4 |
| Cash flows with NCA | 40 | 51 | 66 | 79 | 85 | 95 |
Cash flows without the agreement
| Rs. lakhs | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 |
|---|---|---|---|---|---|---|
| EBIT | 70 | 80 | 100 | 115 | 120 | 130 |
| Less: Income tax @ 35% | 25 | 28 | 35 | 40 | 42 | 46 |
| Net income | 45 | 52 | 65 | 75 | 78 | 84 |
| Add: Depreciation | 4 | 4 | 4 | 4 | 3 | 3 |
| Less: CAPEX | 20 | 20 | 15 | 10 | 10 | 8 |
| Less: Increase in WC | 7 | 9 | 8 | 8 | 7 | 6 |
| Cash flows without NCA | 22 | 27 | 46 | 61 | 64 | 73 |
The valuation
| Rs. lakhs | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 |
|---|---|---|---|---|---|---|
| Difference in cash flows | 18 | 24 | 20 | 18 | 21 | 22 |
| Discount factor @ 17% | 0.8547 | 0.7305 | 0.6244 | 0.5337 | 0.4561 | 0.3898 |
| PV of difference | 15 | 18 | 12 | 10 | 10 | 9 |
Sum of differential cash flows 74; probability of competition 0.5; value of the non-competition agreement 37.
First: the difference is taken on free cash flow, not on profit. The EBIT gap in 2020 is 30 (100 against 70); the cash flow gap is 18. Tax takes 35 per cent of the difference, and the working capital lines move it further.
That matters because a valuer working from EBIT alone would overstate the covenant by two thirds in the first year. The Standard's step is explicit — obtain the projections comprising revenue, expenses, working capital and capital expenditure under both scenarios.
Second: working capital behaves differently in each scenario, and the pattern is instructive. With the covenant, the increase in working capital decreases by Rs. 1 lac each year, starting from Rs. 9 lacs in 2020 — 9, 8, 7, 6, 5, 4, a business settling into a stable position. Without it, the requirement runs 7, 9, 8, 8, 7, 6 — lower at first, because the business is smaller, then higher and erratic as it fights for share.
Note that in 2021 the without-scenario working capital outflow (9) exceeds the with-scenario one (8), even though the without-scenario business is smaller. Competition costs working capital as well as margin.
The rest is familiar. The depreciation and capex lines are identical in both tables, which honours the requirement that all other factors relating to valuation should remain constant. And the 50% probability halves 74 to 37, because the covenant is only worth the harm it prevents multiplied by the chance of that harm.
What the value represents
The Non-Competition Agreement's value reflects the financial benefit XYZ Ltd. gains by preventing competition, ensuring higher cash flows and profitability over time.
Note that the covenant here is with key employees rather than a selling shareholder. That strengthens the case for a probability below one: an employee's ability to set up in competition depends on capital and customer following they may not have.
Common mistakes
- Differencing EBIT rather than free cash flow.
- Holding working capital identical across the two scenarios.
- Varying capex or depreciation between the scenarios.
- Omitting the probability of competition from the premium profit method.