Slide 1:Buying or Selling a Business Understanding the Business Profitability


Small Business Financials :Small Business Financials Recast Financials Seller desires to lessen tax distorts data If business exists 3 or more years, this suggests they are making money Many people live out of their companies expensing personal benefits to the business The top line is important, the bottom line is important, but what is in between tells the real story


Recasting Financials :Recasting Financials The two financial documents that are adjusted are the Income Statement Balance Sheet


What is Recasting :What is Recasting Adjust The INCOME STATEMENT to determine SELLERS DISCRETIONARY EARNINGS (SDE) SDE is the amount of money the business generates to pay debt service and provide wages for the owner/operator An adjusted Income Statements gives the buyer an economic view of the business so a buyer can compare different businesses equally


What is Recasting :What is Recasting Adjust the BALANCE SHEET to Fair Market Value of the Assets to be transferred to a new owner Furniture, Fixtures & Equipment Inventory Accounts Receivables (not typical in small business sales) Banks will loan on assets and cash flow


Recasting Financials :Recasting Financials Everyone has a different meaning of “Business Earnings” Possible Definitions: SDE - Seller’s Discretionary Earnings This is what we use for small businesses This can be equate to the owner’s lifestyle he is living out of the business EBITDA - Earnings Before Interest, Taxes, Depreciation, & Amortization This is typically used for larger businesses Private Equity Groups or Investors not managing the day-to-day operations will typically use this term The easiest way to think of EBITDA is that you calculate the SDE but then you subtract out a cost for a full-time manager’s salary and benefits since there will be an expense for someone running the show Net Income (or Net Profit) – Bottom line of tax return after all expenses Doesn’t really apply to small businesses since only the owner, accountant, and IRS are the only individuals to see this number. The goal in small business is to minimize so that less taxes are paid.


Recasting Income Statements :Recasting Income Statements Recasting Example: Real Life Business We Sold 2004 Unadjusted Pre-Tax Profit = $43,721 2004 SDE = $277,076 An uneducated Buyer & Seller could view the profitability as $43,721 vs. $277,076 This is over a 600% difference!


Recasting Income Statements :Recasting Income Statements What items are typically adjusted? Depreciation Amortization Interest Officer Compensation Family salaries/benefits Officer Insurance Officer Auto Officer Fringe Benefits Rent Replacement Employees Sometimes positive, sometimes negative You must understand when you can adjust and when it must stay.


Recasting Income Statements :Recasting Income Statements The bottom of the tax returns read: The owner’s lifestyle reflects the above numbers plus:


Recasting Income Statements :Recasting Income Statements Though the owner spent his “earnings” as shown on the previous slides, as a business buyer, you have the above amounts to spend to your discretion. This would include paying yourself a salary and servicing the debt required to purchase the business.


Recasting Income Statements :Recasting Income Statements General rule when recasting: If a new owner walked in today to replace the current owner, ask yourself, “What expenses are necessary to generate the current level of sales?”


Recasting Income Statements :Recasting Income Statements Items to think about that we have seen in the past: Owner currently pays his employees 100% medical while his competitors don’t pay medical. Can you add this back? As an area developer of a franchise, the current owner pays 4.5% royalties versus the typical 6% royalty. Is an adjustment needed? The owner owns the real estate in a separate corporation and leases it to his business. The Fair Market Rent for the area is $2000 per month. To lower his business taxes, he charges the business $2500. Is an adjustment needed? For the example above, times now have been tough for the business so he decides to cut the rent to $1500 per month. Is an adjustment needed?


Recasting Income Statements :Recasting Income Statements More questions to think about: The owner takes a salary of $80,000 and works full-time in the business. This is a fair market price for a person in this role in the company. The owner’s wife does all of the accounts receivable and accounts payable for the business. She works approximately 35 hours a week doing these functions. So they don’t have to pay social security taxes for both of them, she doesn’t take a salary since the $80,000 is sufficient for them to live on. Is an adjustment needed? The owner has a flower shop. He is expensing the delivery van through the business. Is an adjustment needed? The owner of the flower shop is expensing his BMW through the business. Is an adjustment needed?


Recasting Income Statements :Recasting Income Statements More questions to think about: The owner has a home-based travel business. The business spends $50 per month for internet service. Is an adjustment needed? The owner has a brother that works in the business who manages the paint department. A person of that skill level typically makes $35,000 per year. Because he is the owner’s brother, he is making $55,000 per year. Is an adjustment needed?


Recasting Income Statements :Recasting Income Statements Remember: You will not be able to accurately recast the financials of a business by just looking at the income statements or tax returns You have to ask questions to understand where add-backs (or subtractions) may exist


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