Adjusted net income (also referred to as cash flow, and sellers discretionary income) is the amount of money an owner actually receives from his or her business, a figure that may be substantially different from the net income - also called profit or net earnings - shown on the profit and loss statement for the business. The difference results from adjustments made to net income shown on the books, in order to demonstrate actual earnings to prospective buyers of the business.
The adjustment is necessary because most business owners take advantage of tax laws to minimize the amount shown on the business’s "bottom line." They seek to show minimal net income in order to pay minimal income taxes. This is legal if done properly, and applies to a business entity whether a sole proprietorship, partnership or corporation.
When the owner wants to sell, the fact that minimal net income is reflected in the business books can be a problem because the value of the business - that is, the price the seller can expect to receive for the business--is based largely on its net income. How does the business owner show minimal income to enjoy low tax exposure, but when it’s time to sell, can claim that earnings actually are greater than the figures shown on the books, in order to boost the value, and sale price? That contradiction is resolved by adjusting or "restating" earnings shown, by adding back, to the net income figure, the business expenses that were claimed on the books submitted with tax returns.
Some of the "add backs" a buyer can expect to see after net earnings have been adjusted, include non-cash expenses such as depreciation and amortization. The IRS allows deductions for these "business expenses" even though the amounts listed are not spent and can be withdrawn by the owner for personal use. Other business expenses that can be added back are those incurred under the present ownership, but might not be charged to the business with a new owner. These include interest payments charged to the business on loans taken out to purchase the business, and the amount of income taxes paid, which - as explained here--are a function of the way the owner chooses to adjust net income declared.
Personal expenses, such as health and auto insurance premiums, vehicle expenses, travel and entertainment costs, may be shown as business expenses, although not necessarily needed to operate the business.