Adjusting Financial Accounts

Before placing a value on your business, or putting it on the market you must have a clear understanding of the exact financial situation of the business. It is normal practice, and quite legitimate for vendors to adjust the financial accounts of the business by adding back certain costs which will not be passed on to the purchaser. The buyer should always be made aware of all the “add backs” and there is normally a certain level of negotiation around the subject. The purpose of “adding back” is to arrive at a profit figure for the business which can be agreed on by all involved, and which can also be used to establish the selling price.  

This practice provides the buyer with the most relevant picture of the financial situation of the business, and of the owners reward. The buyer will access the information to ensure that the add backs do not include anything which will be a continued expense after transfer.  

Some of the most common “add backs” are:  

Personal Expenses which include private motor costs.
Excessive wages taken by the owner.
Interest paid on the current owners finance.  

After these adjustments have been made you will now have the “adjusted net profit” of the business, this is known as the pre tax profit, or Earnings Before Income Tax (EBIT)  

Depreciation
Some people when valuing a business will add back the depreciation on the plant and equipment, this is usually a debatable point between seller and buyer. From the sellers point of view the depreciation is a tax deductible expense and is therefore entered into the accounts to minimize tax. Because of this most sellers will assume that the depreciation should be added back. If you look at depreciation add backs from the purchasers point of view they will argue that depreciation on the equipment will be a continuing expense and therefore should not be added back. It is easy to see the argument from both sides and the buyer and seller will need to come to an agreement that they are happy with. Your own personal opinion will probably depend on which side of the deal you are on.