Normalized earnings is the profit that would continue to the new owner after the old owner left the business. In theory, it is the profit after the owner is paid a reasonable salary that would be earned after the business is sold. What should be factored into this calculation? There is no standard of what to include and not to include the businesses is becoming more international, there are many more things affecting a business. Should you consider them before offering a price for the business for sale?
What should you consider in normalized earnings
- profit per the financial statements
- add back salaries of family members who not working in the business
- add back personal expenses which will not continue after the sale of the business. But what should these include, owners want to say everything is personal and should be added back. The onus is on the seller of the business to prove that it was not a normal business expense
- with a large amount of infrastructure investment going on by the government, these are limited time abnormal sales. Should these be treated separately? They will not continue in a year or two, they are up to a three year potential increase in revenues and profits
- foreign currency fluctuations, if the owner hedges the foreign currency fluctuations or does not hedge the exchange when he sells to the US or a foreign country. Is the method of speculating on currency a normal business transaction or should there be an adjustment?
- unusual advertising programs which failed – some people have tried to argue is to be added back however, if you did not undertake that advertising, would you undertake another form that may be successful?
- personal travel
- depreciation and amortization relating to personal items purchased and set up as a capital asset and amortized for accounting and tax purposes over a period of time
- inventory – some owners will write down inventory which is good and state that they are just trying to reduce taxes – do you think that their argument is valid, they can’t argue it both ways? I have seen one seller want to recover some of the written down inventory when he sold it. The fact that they old owner could not sell it for years would imply there is not a lot of value but he wanted to argue that he should be rewarded down the road for selling something that he could not succeed in selling. Needless to say, the buyer of the business did not agree to this term
- do you factor in rent – too large or too small a location and it needs to be moved. Some people work out of their house and they charge no rent but the new owner must rent space and pay rent. This needs to be deducted from profits to come up with what the profits will be in the future.
This is just a sample of items to consider when determining what is normalized earnings.