Normalization of Income
“Normalizing Adjustments” are essential to value a Company and to make meaningful comparisons between a Company’s past and future performances. The normalization of the financial statements should reflect a willing buyer’s expectations for operating results and assist in determining the appropriate future cash flow stream. In order to minimize confusion and disagreements between Buyer and Seller, adjustments should be:
- Supported by detailed explanations and authoritative references.
- Reflective of all relevant factors.
- Reasonable and necessary.
Normalization generally involves adjusting for a number of broad categories:
- Unusual, Nonrecurring or Extraordinary Items: highly abnormal; non-recurring in the foreseeable future; or unusual in nature and infrequent occurrence.
- Non-operating Items: assets, liabilities, related earnings and expenses not associated with true operating performance.
- Unusual Accounting Conventions: nonconformance with GAAP; industries with unique accounting habits; and changes in accounting methods.
- Appropriateness of ownership controlled expenses: compensation, perks and family member expenses.
The appropriate adjustments to normalize income require substantial effort on the part of your M&A professional. It is the cornerstone upon which the Seller and Buyer make their determination of a sale/purchase price.