Most businesses are valued based on a multiple of their profits, and demonstrating more profit will lead to more money when you sell. One way of doing this that many business owners overlook is normalising your profits. This means taking certain incomes and expenses out of your profit and loss statement to give a more accurate picture of your operating costs. It’s worth taking the time to do this because it can add thousands to the final value of your business.
Normal vs Abnormal Years
Every business has normal years and not-so-normal. In not-normal years, extraordinary things — for the good and bad — happen. If you own a hotel, an abnormal year could be where the pipes burst and flood the rooms, bringing a large repair bill. It could also be the year your city hosted the Rugby World Cup and you had full occupancy for six weeks.
In both cases, the extraordinary expenses and income should be taken out of the normalised profit figure when it’s time to calculate the value of your business. A buyer isn’t interested in high profits that aren’t repeatable every year, and you shouldn’t be penalised for expenses that aren’t incurred on a regular basis.
Calculating Value
To calculate value, a buyer will start with your EBITDA, or earnings before interest, taxes, depreciation or amortisation. Interest, taxes, depreciation and amortisation are taken out of the figure because all owners will handle them differently based on factors like loan arrangements and tax strategy.
From this basic EBITDA, certain expenses are added back to form an adjusted EBITDA. Add-backs are expenses being paid for by the business, which the new owner won’t need to pay. This is important because an offer is generally based on the adjusted EBITDA, and every dollar you can add back to that is worth multiple dollars in your pocket. For example, if your repair expenses came to $25,000, and your business is valued at EBITDA times four, adding that back equals another $100,000 when you sell.
What Counts as an Add-Back
Add-backs can include personal expenses, certain business expenses and one-off expenses. One-off expenses, such as lawsuits or insurance costs, will generally be the first added back. The cost to develop a new product, which is no longer paid once the product is developed, is also included. Other business expenses to add back are rent if you don’t pay market value and certain inventory, repair and maintenance costs.
Owner expenses will generally include personal items that aren’t essential to running the businesses but are included in the income sheet for tax purposes. Things like vehicles, travel, club memberships or entertainment are common add-backs. Salaries may also be included, especially if you pay a spouse or family member who isn’t active in the business. If you as the owner get paid less than a manager would but get a large bonus each year, the bonus may also be an add-back.
Add-backs are often questioned during due diligence, so make sure you can provide proof and justification for everything you add back.
Bringing in Experts
Normalising your accounts is an area where it can be good to get some expert help. Brokers regularly help businesses with this task and know where to look to find adjustments. For example, a broker will look in your “other expenses,” where miscellaneous expenses that can be added to your EBITDA are often filed away. Considering how much each of these add-backs can add to your bottom line, reaching out for help to maximise your profits is a really great investment.
Normalising your accounts can take time, but it will give you and your potential buyer an accurate accounting of your business’s potential. It will also increase the value of your business, making it an essential part of preparing to sell. Take the time to maximise your adjusted EBITDA at the start of the process to ensure you receive an offer that truly reflects the value of your business.
For further information, contact your nearest LINK Business Broking Office.
