Common Add-Backs in Business Valuation
To understand what a common add-back is, we must first define it. For starters, an add-back is an expense that is added back to the profits of the business. Most often it applies to earnings before interest, taxes, depreciation, amortization, or EBITDA. This is for the purpose of improving the profit situation of the company. Add-backs show what the company’s true cash flow is. This in turn shows the best value of the business. Common add-backs are beneficial for the seller and buyer as they provide the most accurate value of the business.
At Peak Business Valuation, our business appraisers seek to provide the most realistic value for your business. We take into account all potential add-backs that might impact the value of your business. Whether buying or selling, it is important to consider obtaining a business valuation. For more information, please reach out. We are happy to answer any questions you may have. Schedule your free consultation below.
Common Add-Backs
In the following paragraphs, we will discuss a few of the common add-backs that occur in a business valuation. With any questions, schedule a free consultation with Peak Business Valuation, business appraiser.
Personal Expenses
Personal expenses are often run through the business to reduce tax liability. Because of this, personal expenses are a very common add-back. Many business owners run their personal expenses through the company. These can include car, personal travel, meals, entertainment, family members on the payroll that are non-working for the business, or any other personal expenses. However, when the owner sells the business, these expenses disappear. As such, personal expenses will always be an add-back to reflect a more realistic value of the business. When obtaining a business valuation, the borrower should provide such information. This helps the business appraiser better understand the value of the business.
Non-Recurring Expenses
Non-recurring expenses are expenses that are not likely to happen again in the future. These can include legal, bad debt, donations, losses, etc… A current common non-recurring expense is a PPP loan. Many businesses obtained a PPP loan as a result of the Covid-19 pandemic. As businesses struggled, the government provided loans to help companies survive and continue to operate. In most cases, these loans are forgiven.
Because non-recurring expenses are inconsistent, they do not reflect an accurate value of a business. As such, they are a common add-back. Oftentimes when an ownership change happens, these non-recurring expenses do not follow. Non-recurring expenses are on the balance sheet. However, investors or buyers like to know which expenses are recurring vs. non-recurring.
Non-Operating Expenses
Non-operating expenses are expenses that happen outside of the business’s day-to-day activities. These expenses do not relate to the company’s core operations. Non-operating expenses are usually considered an add-back because they distract from the direct business activities. One common example of this is interest charges on debts. Investors and buyers are more interested in the core operations of the business. Non-operating expenses appear towards the bottom of the company’s income statement. As they do not directly correlate to the business. As such, they are considered an add-back to help the business appraiser and business valuation focus more on the true value of the company.
Owner’s Compensation
Last, as you can imagine, a business owner often takes a salary. However, a business owner could be paying themselves more, or potentially less, than what it would cost to hire a replacement. When a business appraiser looks at this add-back, they usually compare it to the fair market salary. The business appraiser will then add back the compensation gap to compensate for the difference. This is important information to have when performing a business valuation as it will impact the value of the business. This type of add-back can positively or negatively impact the value of the business.
Summary
There are many expenses that can be considered an add-back. It is necessary to look at the true value of a business when buying or selling. The best way to understand the fair market value is to obtain a business valuation. At Peak Business Valuation, business appraiser, we will analyze each add-back before determining a fair market value.
We look forward to helping you with your business valuation needs. Whether buying or selling a business, a business valuation will establish a better understanding of your business’s worth. Consider Peak Business Valuation, business appraiser, for your business appraisal needs. Schedule your free consultation below.
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