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Normalising Your Accounts
Some business owners love doing their own financial accounting. Others have all their receipts stuffed in shoeboxes under the bed. Unfortunately for the shoebox filers, normalising your accounts is an important step in sale preparation. Normalising doesn’t mean filing your receipts correctly, though you should do that. It means taking certain expenses and income out of your profit and loss statement to show potential buyers a more accurate picture of your operating costs and potential profits.
EBITDA vs. Adjusted EBITDA
This normalised number is your earnings before interest, tax, depreciation and amortisation, or EBITDA. The basic EBITDA is your operating costs plus depreciation and amortisation. Interest, tax, depreciation and amortisation are generally handled differently by different owners, depending on factors such as loan arrangements and tax strategy.
Some buyers look at this as the reported EBITDA and will then look at add-backs to form an adjusted EBITDA. The add-backs are expenses that are currently included in the income statement, and thus the EBITDA, but won't be expenses for the new owners. This can consist of regular expenses such as an owner’s salary, as well as one-time costs that aren't an ordinary business expense.
Why It’s Important
Most buyers will use your adjusted EBITDA as the basis for their offer. Generally, the value of your company, and the offer from the buyer, comes from your profits multiplied by a specific number. The higher your profits, the higher the offer. This means adding expenses back into your accounts is essential to receiving an offer worthy of your business.
As an example, if you had a one-off legal expense of $25,000, and the buyer made an offer of your EBITDA times four, that add-back equals an extra $100,000 in your pocket at settlement. Of course, the opposite is also true. If you've been underpaying yourself and need to take a more realistic wage, this may lower your EBITDA. Some business owners try to hide or minimise this, but buyers will likely pick it up in due diligence. Add-backs are often questioned, so make sure you can prove anything you have added back. Being honest about your negative adjustments will help build trust between you and the buyer, making for a smoother sales negotiation.
What to Add Back
Add-backs are generally personal or non-recurring expenses that the new owner won't have to pay. Business expenses can cover rent that isn’t at market value, inventory, or repairs and maintenance costs, depending on how you structure them. One-off expenses should also be included; for example, lawsuit or insurance costs, one-time professional fees and the cost to develop a new product.
Owner expenses can include personal items such as a vehicle, entertainment, travel and club memberships that aren’t essential to running the business but are included in the income sheet for tax mitigation. As mentioned, think about your salary as the owner. Perhaps you’re underpaid but get a large bonus every year. The bonus is often an add-back, as are the wages of spouses or family members who aren’t active in the business.
Brokers know how to look for these adjustments, so they can get you the best adjusted EBITDA for your business. For example, they know to go through your other expenses, where miscellaneous items are usually filed, to see if there are any adjustments. These adjustments can add quite a bit to your bottom line, so reaching out for help to maximise your adjusted profits will get you a more significant return on your investment.
Taking the time to go through your expenses and determine your adjusted EBITDA gives you and your potential buyer an accurate picture of the operating costs and potential of your business. It’s also an opportunity for you to increase the value of your company. Add normalising accounts to your pre-sale checklist and make sure you get some help to add as much back into your EBITDA as possible.
Contact one of our LINK Offices and speak with our expert team of brokers to help you buy or sell a business smoothly and confidentially.