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What is a normalisation adjustment?

By
Lucas Couper
Lucas Couper
Director
September 6, 2018
5
minute read

Everything you need to know about normalisation adjustments and how they impact business sales

Whether you're new to selling a business or looking to acquire one, you're probably familiar with the term 'normalisation' or 'add backs'. Normalising figures from accounts is a common process before selling your business and a key part of preparing a business for sale.

The purpose of normalisations are to present the earnings of a company without the impact of unusual or one-off situations. The normalisation process adjusts non-recurring expenses and revenue accounts both upwards and downwards to illustrate the true earnings of a business.

Normalisations can enhance sale value by enabling reliable comparisons and projections, and providing prospective buyers with a crystal-clear picture of the core expenses, revenues and cash flows for a business during a particular period.

Typically, any buyer or investor will want to see normalised financial statements when investigating a buy-out to gauge the trends of a business over a medium time period.

If you're considering selling your business, it's essential to understand how normalisation can enhance sale value. Contact our expert team of financial directors on [phone] today.

Business advisers assessing normalisation adjustment

Using EBITDA to arrive at a valuation

Normalisations are a crucial step in the valuation process - without normalisation adjustments, financial statements may contain revenues or expenses that do not reflect normal business operations and may dissuade a prospective buyer, or materially impact valuations.

The most popular normalisation process is based on the financial management metric 'EBITDA' (Earnings Before Interest, Taxes, Depreciation, and Amortisation). Normalising up a company's EBITDA is common practice when selling a business.

As a financial metric, EBITDA adjusts the profits of your company by taking an approximate measure of its net profit, then adding back taxes, interest, depreciation, amortisation and other non-operating expenses.

At Nash, we have a growing list of over 80 types of normalisation adjustments that will affect EBITDA. Some of the most frequently adjusted accounts include:

  • Management salaries: Often sky-high instead of standard wage, management salaries are typically adjusted or 'normalised' to the baseline amount required for new owners to operate the company effectively.
  • Non-core expenses: These include voluntary expenses that won't be incurred by new owners if you sell up - think company cars, work phones, petrol cards and other perks such as kitchen supplies and one-off professional memberships.
  • Commercial rent or property costs: What you have paid to lease the property in previous financial years is irrelevant - property costs must be adjusted to reflect current market conditions.
  • One-time events or expenses: Part of the normalisation process involves deducting unresolved expenses that remain in your business as well as non-recurring expenses from one-time events such as building renovations.

Why normalisation is required

Most business valuation methods rely on the premise that a business's true value lies in its ability to earn an investor money in the future. A business valuation usually involves projecting the future level of cash flow for a company using a normalised record of past earnings for reference.

The expected normalised cash flows are multiplied by a capitalisation factor, which reflects the rate of return a buyer might reasonably expect on their investment combined with a measure of the risk involved that these expected earnings will not be achieved.

A significant portion of buyer due diligence revolves around reviewing the normalisation adjustments listed by vendors, so you cannot discount the value of getting a reputable financial advisor to dig into your numbers and thinking about ways to reduce them. It will lead to a more accurate EBITDA or measure of profit, and likely increase the value of your business upon a sale.

How much is your business worth?

If you're selling your business, it goes without saying that you want to maximise your odds of selling it for the highest price. Understanding normalisations and discussing it with your financial adviser is but one step of many in the valuation process.

Even if you're not planning on selling your business any time soon, there are multiple reasons to have an up-to-date business valuation done, including to source bank finance, implement an employee share plan, or to deal with shareholder disputes.

There is a range of valuation techniques that are employed to determine the value of a company, and no single approach will fit all situations. At Nash, we undertake deep research on all of our clients to determine the unique factors that will affect their valuation.

Selling a business is rarely simple, so it pays to get it done right.

  • Ensure normalisations are on commercial terms, and balanced both on the positive and negative sides
  • Ensure all the details of the transaction are favourable for your business and free from error or omission for investors.
  • At Nash Advisory, we can ensure that your normalisation adjustments are accurate and legitimate.

For more information about normalisations and business valuations, talk to the Nash team on [phone].

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