Key points
- Small and midsize companies are priced on adjusted earnings, so each accepted adjustment is multiplied by the price multiple.
- Accepted adjustments are documented, belong to the owner or happen once.
- Owner draws and one time income are not earnings.
- Cash that never reached the books adds nothing to value.
Why the adjustments move the price
Main Street buyers value a company on seller's discretionary earnings, meaning profit before the owner's pay, benefits and perks. Bigger firms are priced on adjusted EBITDA, which swaps in a market rate manager.
Most companies trade near two to three times that number. A real $30,000 adjustment can therefore move the price by $60,000 to $90,000.
What buyers usually accept
- The owner's salary and payroll taxes, for a working owner
- Health insurance and retirement contributions for the owner
- A personal vehicle or phone paid by the company
- A one time cost such as a settlement, a move or an unusual repair
- Family payroll for people who do not work in the business
Each needs paper behind it: an invoice, a payroll record or a receipt.
What buyers push back on
Costs that look like normal expenses under a different name get rejected. Repairs that recur every year, a work truck and marketing you must keep paying stay in the numbers.
Money from selling an old vehicle or from a loan is not operating income. Owner draws are not earnings either, since they never appear on the profit and loss statement.
Unreported cash
Cash that never reached the books cannot be proven, so it does not raise your price. Saving about 20 percent in tax can cost far more when the multiple is two to three times earnings.
A worked example
Say profit before tax is $200,000. You pay yourself $90,000, run $12,000 of health insurance through the company and paid $18,000 for a one time legal settlement. Adjusted earnings come to about $320,000.
At a multiple of 2.5, the company is worth around $800,000. If the buyer rejects the settlement, the figure falls by about $45,000. That is why each line needs support.
How to prepare
Ask your CPA for a recast profit and loss statement for three years, with each adjustment listed and supported. Keep current statements, since buyers weigh the latest twelve months most.
Equipment heavy firms should expect buyers to deduct maintenance spending from depreciation adjustments. Once your numbers are clean, request a value estimate, and read working capital in a business sale.