NORMALIZED NET INCOME
Determining the Normalized Net Income is the first and most important step in determining the value of your small business; any other term implying the same thing is suspect. (Small business being less than ten million dollars in sales.)
If you are reading financial information about a small company and you see the terms, owner's discretionary income, seller's discretionary income, seller's discretionary earnings, free cash flow, seller's discretionary cash flow or owner's cash flow, BE CAUTIOUS! These are terms that people feel they can trust but in fact they are often very misleading. You may also see the term EBITDA, this is a legitimate term when used in the right context.
If these terms are used in relation to the sale of a small business, someone (usually the buyer) is being misled. The manager's of banks and other financial institutions have been mislead by these terms so often that their head offices are often very skeptical about financing the purchase of a small business.
OWNER'S DISCRETIONARY INCOME:
If the people selling the franchise were being truthful they would use the term NORMALIZED NET INCOME which would show the profit AFTER everything, including the owners wages, were paid out at fair market value. If the fair market value of the plumber's/owner's wages were $70,000 the true profit figure would be $20,000 NOT $90,000.
The perpetrators are generally white shirt and tie and go to great lengths to convince buyers they are professionals, and in a dark way that is true.
FREE CASH FLOW, OWNER'S CASH FLOW and OWNER'S DISCRETIONARY INCOME are all 'weasel' words used in the process of separating people from their hard earned money.
EBITDA (Earnings Before
Interest, Taxes, Depreciation and Amortization)
EBITDA is generally used as a measure of a company’s operating cash flow based on stated earning from financial statements BEFORE interest, taxes, depreciation and amortization.
INSIST ON NORMALIZED NET INCOME
Reasons to insist on Normalized Net Income:
Once the true NORMALIZED NET INCOME is established you will need to obtain a professional assessment on RISK and OPPORTUNITY to determine the ratio or multiple to use. This ratio of the Normalized Net Income will determine the value of the cash flow, or what some people call the goodwill, of the business.
Next, one must consider HARD ASSETS and INTANGIBLE ASSETS.
I can think of a current situation where the INTANGIBLE assets are worth in the range of ten million dollars but none of this shows on the balance sheet.
I hope this information is helpful to you.
My niche is Small Business Valuations with special expertise in understanding intangible assets which are often missed as they don't show up on the balance sheet. In addition to financial statements, I take into account processes, procedures, the knowledge base of owner and employees, the value of employees (recruitment and training,) the value of the client base, internet presence and use, documentation and risk.
The rate of return on the real normalized net income is always the first and last consideration. Value to whom? The bank, the seller, the buyer (our valuations can include more than one.) This is why PIN Valuations are more accurate than most.
The process is this:
The turnaround time is estimated at one week from the time I receive your financials.
I work across North America.