In order to understand what is going on in a small business,
a process of normalizing the income statement is necessary.
We need to understand the true benefit of ownership. Sometimes, personal benefits are hidden in
the expense lines. For example: a
restaurateur who takes personal groceries home from the business. These items can add up substantially.
In the normal process of doing this, the analyst takes the
net income and then starts ‘adding-back’ items to get a new normalized cash
flow. This cash flow figure is called
the Seller’s Discretionary Earnings or SDE.
It is the total cash available to an owner of the business.
Small businesses are typically valued as a multiple of SDE.
Here’s the problem: sometimes owners don’t take a salary
which would appear in the wages expense, they instead take dividends which
happens on the balance sheet.
Net income from an income statement appears in the equity
section of the balance sheet. At the end
of the year, it gets rolled into ‘retained earnings.’
So if a seller is taking dividends, it is removed from the
equity section of the balance sheet. If
you add the dividends to net income, you are effectively double-counting the
same dollars.
Don’t let it happen to you.
Learn how to buy a business the right way and control
risk. Visit www.BusinessBuyerAdvantage.com
to learn more. If you want to engage my
help, send me a message or call me at 506 381 8416. I work with people all around the world.
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