Some basic guidelines for “normalizing and adjusting” financial statements.
If you are looking into the possibility of selling your company, you may have heard about something called “normalizing” or adjusting your income statement and balance sheet. This process adjusts for items that appear on your financial statements that would likely not be there if someone else bought the business. They impact your bottom line, and a buyer excludes them to calculate the “real” cash flow or income from the business to determine the value of the company.
“Normalizing” your cash flow will also make your financial statements more easily comparable to other businesses. Normalizing involves adjusting items in the financial statements that are not considered to be “normal” operating expenses of the business. I remember the business owner in Florida (in the financial services industry) who considered his yacht expenses to be legitimate marketing expenses for his business. He owned a private company and frequently entertained his potential clients on his yacht. For his CPA and his taxes, these were business expenses.
We were the potential buyer and a public company. For purposes of determining his company’s cash flow, we “normalized” those and other personal expenses out of his financial statements to determine what his net income really was. He liked the effect this would have on his purchase price, BUT he did not like the fact that if he sold to us, we would no longer be paying for his yacht and its related expenses. Since he was going to continue working with us in sales, he wanted to continue to treat his clients and prospects in the manner to which they had become accustomed! (By the way, the expenses alone were pushing $300,000/year 20 ago.)
I haven’t seen any landscape companies with that level of “marketing expense,” but there are usually several adjustments that can be made, especially for a small or medium-sized business. Here is a “starter list” of 10 for you to consider. When you are thinking about digging into your financial statements with your CPA, you might want to look at your own “adjusted net income” and “adjusted cash flow” to see how those results stack up to industry benchmarks.
For Income Statement Normalization and Discretionary Adjustments (there are other examples for Balance Sheet and, of course, they ultimately will impact each other.)
- Officer’s and owner’s compensation –Often set below market for tax reasons and must be adjusted to the amount needed to attract a qualified person to replace the owner
- Officers’ retirement plan contributions
- Officers’ perquisites – country club dues, for example
- Family members compensation (if not working in the business)
- Other payroll adjustments – the business probably won’t need that private chef or your nanny to operate
- Entertaining expenses
- Vehicle expenses – the difference between the truck everyone uses and the Rolls Royce the owner drives
- Non-operating asset and expenses –rent related to that condo in the mountains that is not needed to run the business.
- Depreciation expense
- Interest expense
A business valuator will collect a large amount of information from you which he/she will analyze and make an assessment about the “true” cash flow along with risk factors that should be applied to it. You can get an insight into the cash flow by working on your own numbers with your accounting professional. Once you’ve done the calculations, you can compare them to other landscape industry valuations or engage a valuation professional to prepare a valuation using that rigorous process and methods that vary depending on the purpose of the valuation. That kind of valuation is an excellent starting point for your thinking about your exit plan.
If you would like to discuss your exit plan, how a buyer would value your business, how to sell your business or how to buy another business, let’s chat. Have you bought a business and are having trouble integrating it? We can help with that too.
I can be reached anytime via email: [email protected] or phone at: 224-688-8838.
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