Valuing a Business: Non-Recurring ExpensesValuing a business for any reason – particularly in anticipation of bringing it to market – involves significant analysis and dozens of issues to consider. One of those issues is what’s called “non-recurring expenses”. Non-recurring expenses are those that the business does not incur on an annual basis. For example, capital expenses are generally non-recurring. “Capital” expenses can cover a wide range of things such as replacing computers, printers, servers, etc. at the end of their life cycle; acquiring a new delivery truck; the costs of expanding or upgrading a business’ space; upgrading a production line; the purchase of new software or retooling for a special project. When valuing a business, capital expense analysis should not necessarily be part of the process – unless such expenses are anticipated. More on that at the end of this post. But what I want to focus on here is “one time” or “extraordinary” expenses, an extremely important category to consider when valuing a business. And brokers must know the difference between discretionary expenses and one-time expenses.
“Adjusted” Net Income: What Goes Into the Owner’s PocketOne-time or extraordinary expenses – I’ll refer to them as one-time expenses from this point forward – are defined as those that the business is extremely unlikely to incur in the future. Why does this matter? Because the value of most Main Street and Lower Middle Market businesses is derived from the business’ “adjusted net income” and one-time expenses are presumed to not be repeated. As the business is usually valued based on expected future net income, identifying and re-categorizing non-recurring expenses is important. Adjusted net income is the result of recasting the financials – the process of determining the actual amount of money the owner of the business can put in his or her pocket. That process entails examining the business’ expenses to determine which ones, either in whole or in part, are not germane to the operation of the business. Both one-time and capital expenses can fall into this category.
Our course, “Learn How to Value and SUCCESSFULLY Sell Businesses“, teaches how to value and sell businesses.
Become a Professional Business Broker…A simple example of an expense that is not pertinent to the business’ operations is one we use in our course, Learn How to Value and Successfully Sell Businesses. That example describes how the owner of a transfer warehouse and freight-forwarding company enjoyed some unusual “owner benefits”. His business leased large freight transfer stations throughout the U. S. and sub-leased portions of those warehouses to major trucking and rail companies. The business’ tenants – UPS, FedEx, and most of the major freight lines – might lease a dozen slots in the building. They bring freight in on one side, break it down inside and load it on to out-bound trailers on the other side. This enables the freight lines to pick up freight in many regions and bring it to a central transfer warehouse for sorting into truck-loads of products destined for particular areas. For example, trucks from all over Michigan, Indiana, Ohio and Kentucky, each loaded with freight destined for delivery to a dozens of locations, pull in to the inbound side of the transfer station where the freight is unloaded, then sorted so that everything headed for Kansas City is loaded on one truck on the outbound side of the transfer station; everything headed for New York into another outbound trailer and so on for other geographic areas. But it turned out that the owner of this business had a fondness for classic cars and one of the warehouses his business leased was in the dry environment of Nevada and was used to store those cars. Because the business broker knew what he was doing, he asked the right questions and discovered the existence of that warehouse and, because it had no relation to the company’s operation whatsoever, the cost of that warehouse was then subtracted from the expense numbers, thus increasing the actual net. This expense was an “owner benefit“.
We’ve launched a coaching program specifically tailored to Realtors that want to sell businesses and to novice business brokers.
If you’d like to learn more, email me at joe@WorldwideBusinessBlog.com