confidential business sale - buying or selling small businesses

Confidential Business Sale, Inc. ConfidentialBusinessSale.com

Buying or Selling a Business

Understanding the Business Profitability


Small Business Financials

Recast Financials

• Seller desires to lessen tax distorts data

• If business exists 3 or more years, this suggests they

are making money

• Many people live out of their companies expensing

personal benefits to the business

• The top line is important, the bottom line is important,

but what is in between tells the real story


Recasting Financials

The two financial documents that are adjusted are the

Income Statement

Balance Sheet


What is Recasting

• Adjust The INCOME STATEMENT to determine

SELLERS DISCRETIONARY EARNINGS (SDE)

• SDE is the amount of money the business generates to

pay debt service and provide wages for the

owner/operator

• An adjusted Income Statements gives the buyer an

economic view of the business so a buyer can compare

different businesses equally


What is Recasting

• Adjust the BALANCE SHEET to Fair Market Value of

the Assets to be transferred to a new owner– Furniture, Fixtures & Equipment

– Inventory

– Accounts Receivables (not typical in small business sales)

• Banks will loan on assets and cash flow


Recasting Financials

Everyone has a different meaning of “Business Earnings”

Possible Definitions:

– SDE - Seller’s Discretionary Earnings– This is what we use for small businesses– This can be equate to the owner’s lifestyle he is living out of the business

– EBITDA - Earnings Before Interest, Taxes, Depreciation, & Amortization– This is typically used for larger businesses– Private Equity Groups or Investors not managing the day-to-day operations

will typically use this term– The easiest way to think of EBITDA is that you calculate the SDE but then

you subtract out a cost for a full-time manager’s salary and benefits since there will be an expense for someone running the show

– Net Income (or Net Profit) – Bottom line of tax return after all expenses– Doesn’t really apply to small businesses since only the owner, accountant,

and IRS are the only individuals to see this number. The goal in small business is to minimize so that less taxes are paid.


Recasting Income Statements

Recasting Example:

Real Life Business We Sold

2004 Unadjusted Pre-Tax Profit =

$43,721

2004 SDE =

$277,076

An uneducated Buyer & Seller could

view the profitability as

$43,721 vs. $277,076

This is over a 600% difference!



What items are typically adjusted?– Depreciation– Amortization– Interest– Officer Compensation– Family salaries/benefits– Officer Insurance– Officer Auto– Officer Fringe Benefits– Rent– Replacement Employees

Sometimes positive, sometimes negative

You must understand when you can adjust and when it must stay.



The bottom of the tax returns read:

The owner’s lifestyle reflects the above numbers plus:



Though the owner spent his “earnings” as shown on the previous slides, as a business buyer, you have the above amounts to spend to your discretion. This would include paying yourself a salary and servicing the debt required to purchase the business.



General rule when recasting:

– If a new owner walked in today to replace the current

owner, ask yourself, “What expenses are necessary to

generate the current level of sales?”



Items to think about that we have seen in the past:

– Owner currently pays his employees 100% medical while his competitors

don’t pay medical. Can you add this back?

– As an area developer of a franchise, the current owner pays 4.5% royalties

versus the typical 6% royalty. Is an adjustment needed?

– The owner owns the real estate in a separate corporation and leases it to his

business. The Fair Market Rent for the area is $2000 per month. To lower his

business taxes, he charges the business $2500. Is an adjustment needed?

– For the example above, times now have been tough for the business so he

decides to cut the rent to $1500 per month. Is an adjustment needed?



More questions to think about:

– The owner takes a salary of $80,000 and works full-time in the business. This

is a fair market price for a person in this role in the company. The owner’s

wife does all of the accounts receivable and accounts payable for the business.

She works approximately 35 hours a week doing these functions. So they

don’t have to pay social security taxes for both of them, she doesn’t take a

salary since the $80,000 is sufficient for them to live on. Is an adjustment

needed?

– The owner has a flower shop. He is expensing the delivery van through the

business. Is an adjustment needed?

– The owner of the flower shop is expensing his BMW through the business. Is

an adjustment needed?



More questions to think about:

– The owner has a home-based travel business. The business

spends $50 per month for internet service. Is an adjustment

needed?

– The owner has a brother that works in the business who manages

the paint department. A person of that skill level typically makes

$35,000 per year. Because he is the owner’s brother, he is

making $55,000 per year. Is an adjustment needed?



Remember:

– You will not be able to accurately recast the financials

of a business by just looking at the income statements or

tax returns

– You have to ask questions to understand where add-

backs (or subtractions) may exist


Contact One of Our 3 Offices

Confidential Business Sale, Inc.

Independence Tower

5755 Granger Rd.

Suite 360

Cleveland, Ohio 44131

Phone: (216) 739-0272

Fax: (216) 739-0279

[email protected]


Laurel Office Park I

17177 N. Laurel Park Drive

Suite 236

Livonia, Michigan 48152

Phone: (313) 221-9378

Fax: (313) 221-9379

[email protected]


StanJim Building

5437 Mahoning Ave.

Suite 2

Youngstown, Ohio 44515

Phone: (330) 423-0879

[email protected]

confidential business sale - buying or selling small businesses

Economy & Finance

business buyer

business taxes

business profitability

small business financials

business ebitda earnings

real life business

recasting financials

homebased travel business