Normalization of Income
How Normalization of Income helps you establish a value for your company.
The first exercise in determining an expression of value of the net worth of shares or assets of a company is to analyze and normalize the company’s financial performance as if it were a company being run “By the Book”.
Today, the basis of the most common “thumbnail” valuation methodology is a multiple of normalized EBITDA. (Earnings Before Interest, Taxes, Depreciation, and Amortization)
- Management Salaries – Careful consideration should be given to what a normal management salary, or salaries, would be for the new owners to operate the company effectively. Net income should be adjusted accordingly.
- Costs that would not exist under new ownership. For example automobiles, cell phone, gas cards, car insurance, internet, and home office costs.
- Family members or others on the books who draw a salary or receive other benefits but do not perform work for the company.
- Commercial rent or property costs should always be adjusted to reflect actual market costs if the new Owner leases the business premises at prevailing market rates.
- Perks that will not exist under new ownership. Examples are personal meals, entertainment and memberships.
- Owners benefits such as key man insurance or personal term or whole life insurance, as well as pension or RRSP contributions being paid for by the company.
Each individual company may have other costs or revenue adjustments that may be required; the above are the most common.
Each company may have other required costs or revenue adjustments; the above are the most common.
A review of the Balance Sheet is needed to determine the company’s actual retained earnings or net worth. This exercise helps identify other assets or liabilities that may impact the company’s valuation.
In a share sale, this review will also determine how much cash to keep in the business as “working capital”. Other essential shareholder items of concern are loans to, or advances from, the company and capital gain taxation considerations.
The final factor to be determined is the appropriate multiple of EBITDA, essential to establishing a provisional value of your company.
The Multiple x Normalized EBITDA = Provisional Value.
Before contacting us, the seller should have this preliminary valuation completed. The following link provides a complimentary EBIT/EBITDA printable worksheet to help establish your company’s value.
Mercantile Mergers & Acquisitions Corporation will happily assist you in this process at no cost or obligation. Contact us here for a free consultation.