Normalised earnings when selling your business
When a family business owner looks to sell their business as part of a succession or exit event, the financial reports prepared by your Perth business accountant will become critical. Your accountant’s vocabulary will inevitably move from a discussion of net profit after tax to normalised earnings.
What are normalised earnings?
Business financial reporting is often clouded by tax strategy. The underlying business profits are sometimes altered by tax strategies engaged by a Perth tax accountant, or a business could have one-off costs that will not be incurred by the purchaser (like a fire).
The concept of normalising earnings is to strip away the noise from the financial reports to understand the true ordinary business activities of the family business that is being sold. It is a different concept to earnings before interest, tax, depreciation and amortisation (EBITDA).
Understanding Normalised Earnings
Normalised earnings present a company’s financial performance by removing the impact of non-recurring gains and losses. This approach helps provide a clearer picture of the business’s core operations and long-term profitability.
One-off items like the sale of outdated, non-operational assets or legal expenses can skew financial results. While these events affect cash flow in the short term, they don’t accurately represent the company’s ongoing performance. These impacts are adjusted or excluded to give stakeholders a more accurate view.
Your normlised earnings are often used to compare against your 3-way forecast when selling the business.
A business has a wide range of normalised earnings that will regularly be adjusted for away from the classical financial reports presented at an Annual General Meeting. This can include:
Often, a director owner of a family business is not paid a wage. The salary paid to the working director might attract payroll tax, and the preference is for the business to pay the owner a higher dividend and avoid payroll tax.
If the family business rents the commercial premises in the owner’s self-managed superannuation fund, the rent is sometimes at the higher range of market value to increase the SMSF’s value and enjoy concessional tax treatment within the SMSF.
A business expanding into new markets will incur considerable cost getting that operation profitable. Suppose a profitable business has a new site and the business loses money while that site is operational. In that case, the new owner will likely not incur those costs as, by the time they acquire the family business, the new site will have managed to break even. So, the loss incurred on that new market development will no longer originate.
The cost of professional fees to prepare a business for sale is not part of a business’s ordinary operational course. These costs are ordinarily normalised.
If a business enjoys a one-off grant to stimulate the economy, the new owner will not get the grant themselves. So, removing the impact of that grant is vital to give the potential purchaser an idea of how to proceed.
How many times to normalise
In a complex economy, it is reasonable to say that businesses rarely have a “normal year.” And it is common to see a seller present a deep and ongoing story of normalisations.
This is a mistake.
You should try to limit normalisations to clear, evident and material adjustments. It is ordinary for a staff member to resign and a business to incur recruitment agent fees. It is ordinary for equipment to need repairs to equipment. It is ordinary for a customer not to pay your account.
Presenting normalised earnings to a purchaser is part of the sale process and supports your business valuation. So, keeping the normalisations small is essential to show credibility and trust to the purchaser.
Getting ready for sale
Selling your business is a complex task. You have the ongoing role of increasing the market share and profits of your current operations, managing your current tax liabilities, and presenting your business operations to a purchaser to get them to buy.
At Westcourt, we only focus on families in business. Selling the family business to fund your exit is the most common strategy with our clients. With our award-winning expertise, deep technical knowledge, global network, and commitment to independent advice, we are the obvious choice for a family business looking to sell. So why not give us a call?
Connect with our team today
