Recasting Your Business Income to Maximize Market Value

Buyers buy cash flow! This is heard often in the business brokerage industry. Why does someone want to buy a business? One of the major reasons is to make money. Profit and loss statements do not reflect the true earnings of a business. Most businesses are operated in a manner to reduce income tax, not to increase profits and pay more taxes. Seller's Discretionary Cash Flow is the benefit to the owner of owning a business. Recasting financial statements is an important step for determining business cash flow.

Business owners sometimes receive personal benefits that are paid by the business. These owner benefits and perks must be captured through recasting the financials. Some of these are acceptable in the eyes of the IRS, while others often cross the gray line. Examples of these include hospital and life insurance, personal vehicles that are owned by the business, travel that is not entirely business related, and many others.

Recasting the income and expense statement is an important feature of the valuation process. The business owner has a responsibility to make certain owner's Discretionary Cash Flow is as accurate as possible. Essentially, all verifiable perks and compensation that a business owner has received will be added back to the Earnings Before Taxes (EBT) figure from the tax form.

Below is a list of potential add-backs for recasting cashflow:
1. Owner's Salary
2. Owner's Vehicles
3. Family Salaries
4. Owner's Insurance
5. Owner's Payroll taxes
6. Owner's Travel and Expenses
7. Non-Essential Telephone
8. Non-Essential Utilities
9. Non-Essential Legal
10. Donations
11. Depreciation
12. Amortization
13. Interest Expense
14. Unusual Non-Recurring Expense
15. Rent Adjustments
16. Bad Debt
17. Bank Charges
18. Penalties and Fines
19. Non-Essential Business Expenses

Occasionally, there will be negative add-backs due to certain business circumstances when recasting the financials. Common negative add-backs are voluntary labor, replacement employees, gains on sales of assets, interest income and others. Make sure negative add-backs are addressed when recasting.

Determining an accurate Seller's Discretionary Cash Flow (SDCF) for a 3 year period is a critical component to obtaining a fair market valuation for a business. A high SDCF will often yield a much higher goodwill adjustment or intangible asset value for the business. It is important that all income and recasting adjustments are verifiable. Otherwise the recasting exercise will become a disaster during buyer due diligence.