Interpreting Reported Earnings From Sellers


Interpreting Reported Earnings

If it's true, as commonly believed, that small business owners tend to be creative individuals, one of the expressions of this talent can be found in the way they calculate the adjusted net income or earnings they receive from their businesses.

Seasoned California business brokers often have difficulty coming up with an accurate earnings figure when analyzing the records of a company going on the market. Their challenge is to determine how much a new owner is likely to earn, based on the current level of gross revenues and the expenses actually needed to generate that income.

If accurately calculating the "bottom line" is hard for someone skilled in this field, imagine the difficulties faced by a real estate licensee with a background in home sales, who is called on to list a small California business opportunity for sale. It's easy to understand how real estate professionals lacking experience in analyzing businesses records, can be misled by a seller into advertising an exaggerated earnings figure for a business offering.

But the agent or broker will soon get an education--the hard way--about the importance of determining and stating the correct figures. That education will begin when the broker goes back to the seller for more information, after a buyer--relying on initial profit statements--discovers in due diligence that there is no way to substantiate the profits claimed.

EBTIDA

The first thing for a new business broker to understand about an earnings statement is the calculation of Earnings Before Taxes, Interest, Depreciation and Amortization. The seller's books will probably show each of these T-I-D-A items as expenses, deducted from the gross profit figure along with other fixed costs, before conducting the final calculation of earnings.

An accepted accounting protocol is to assume that these TIDA expenses will vary, depending on the way each buyer wants to manage the financial side of his or her business. And because these "variable" expenses do not represent costs absolutely necessary to conduct business, the common practice is to add the TIDA expenses to the "bottom line" figure to arrive at the seller's earnings. And this figure should be properly explained as EBTIDA.

ONE-TIME EXPENSES

The cost of a legal settlement with a disgruntled former employee or with an unhappy customer who has some kind of claim, is an example of a non-recurring, or one-time expense. So is the cost of an expensive capital equipment item that was purchased from the business's ready cash in a single year. As these expenses are not going to be incurred by the new owner, it is fair, when analyzing the seller's Profit and Loss Statement, to add the amount of these non-recurring costs to the bottom line.

The buyer may have other one-time costs once the business has changed hands, and will treat them however he or she sees fit for bookkeeping purposes. But any non-recurring costs listed by the seller can legitimately be considered as if the dollar values associated with them are part of the seller's earnings.

PERSONAL EXPENSES

It is common for the owner to have his company pay personal vehicle costs because he uses the car while conducting business, and for an owner to consider it the responsibility of the business to provide her with health insurance, and for an owner to carry a family member on the payroll, even though that person only does occasional, part-time work for the company. These represent business expenses which incidentally, also provide benefit to the owner. And as these are items charged to the business at the discretion of the owner, it is an accepted practice to assume a new owner will not incur the same expenses, and to add these costs to the seller's earnings figure.

Memberships in social/business organizations, such as country clubs and fraternal societies, subscriptions to periodicals and internet services, and other discretionary "business" costs might also be considered "add backs" when determining seller's earnings.

An inexperienced broker listing a business and wanting to enter an owner earnings figure that is correct, and can be logically explained, will benefit by carefully questioning the seller on each item "added back."

But there is no substitute for having worked with these expense entries in the past and knowing from experience, how to calculate seller's actual earnings.

Peter Siegel, MBAAbout The Contributor: Peter Siegel, MBA is the Founder & Senior Advisor (ProBuy & ProSell Programs) at BizBen.com (established 1994, 8000+ CA businesses for sale, 500 new & refreshed postings/posts daily) working with buyers, business owners/sellers, business brokers, agents, investors, and advisors). Reach him direct at 925-785-3118 to discuss strategies regarding buying, selling, (or financing a puchase of) California businesses.

Categories: BizBen Blog Contributor, Business Valuation Issues, How To Buy A Business, How To Sell A Business


Comments Regarding This Blog Post

Contributor: Broker Specialist - MFG's, Southern CA

Whilst Depreciation and Amortization are normal addbacks to calculate either SDE or EBITDA, there are some occasions where CapEx can be an ongoing expense of the business. I had a case several years ago with a Concrete Sidewalk Installation company. They used Bobcat machines to break up the old sidewalks, before installing the new. These machines are typically depreciated over a seven year period, but in reality, required replacement every three years. In this case, the machines had to expenses over three years to reach an accurate net income level.


The difference between the "bottom line" and the REAL bottom line can be extraordinary. And, if the seller is not accurate in identifying every legitimate "add-back", he will leave a lot of value unrecognized. The experienced business broker is essential to that accurate analysis of the seller's finances and the proper presentation and explanation of the resulting "Seller's Discretionary Earnings" ("SDE") to prospective buyers. Furthermore, the primary benchmark for beginning the value of small businesses in the great majority of fields is the SDE; that's the basis for comparison to what buyers have paid for similar businesses.






  Helpful Resources To Assist In Selling And Buying California Businesses
Harry Sidhu, CBB, Broker: SF Bay Area, Central Valley, SAC Region

Assisting both sellers and buyers of businesses - dealing mainly with Liquor Stores, Grocery Markets, Gas Stations, Smoke Shops, Restaurant Related, Retail Related, Service Related. Serving SF Bay Area, North Bay, Sacramento area. Call Harry Sidhu, CBB for assistance at 510-366-6130.

Steve Zimmerman: Restaurant Broker Specialist, California

Steve founded Restaurant Realty in 1996. He has personally sold/leased over 1000 restaurants, bars & clubs, & completed over 3000 valuations. The author of "Restaurant Dealmaker- An Insider's Trade Secrets For Buying a Restaurant, Bar or Club" available on Amazon. Reach Steve direct at 415-945-9701.

William Park, Business Broker: Southern California

Highest Volume Broker in California, Simply Check our HUNDREDS of Listings! Over 25 Associates, Speaking Dozen Languages, Helping Buyers and Sellers of Small Business since 1982, Centrally Located between Los Angeles and Orange Counties, while Riverside & San Bernardino Counties are Very Accessible.

Lee Petsas, Business Broker: Southern California Area

Lee Petsas has been selling businesses with UBI Business Brokers in Southern CA since 1981. In 1999 he became the Owner and Broker for UBI. He has been approved multiple times by Courts as an Expert Witness in the area of Business Valuations.

Julieanna Wakileh, Business Broker: PreSchool Center Specialist

I have 30 years of experience, working, founding, owning, operating, consulting, and selling preschools. I'm very knowledgeable with procedures that are required for selling preschools. My practice, knowledge and education is ideal for the sale of preschool centers. 925-451-2884 Cell/Text.

Steve Erlinger: Laundry Broker, Consultant - Southern California

I specialize in the laundry industry broker and consultant in Southern California. I assist buyers navigate the many facets of finding, evaluating, and operating a laundry business. I also help current laundry owners find additional stores, sell, evaluate an existing laundromat. Call 949-500-5893.

AJ Rana - Business Broker, San Francisco Bay Area

Professionals who understand the importance of world class business brokerage service and the value it can create. Specializing in assisting sellers and buyers with retail stores, restaurants, hospitality & lodging, manufacturing operations, distribution companies, e-commerce and service businesses.

Orville Wright, Business Broker: Central Valley Area

Central Valley Business Brokerage a full service Business Brokerage company. We specialize in assisting business owner/sellers and buyers in these Central Valley Counties: Fresno, Tulare, Kern, Madera, Kings, Mariposa with buying & selling small to mid-sized businesses, valuations, & exit planning.


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