Many times, tax returns and financials do not show a business's true cash flow. Adjustments need to be made to the balance sheet and income statements as part of the business valuation process.
Tax returns and financials need adjusted to show true income for a business valuation
Table of contents
- Tax returns and financials need adjusted to show true income for a business valuation
- Why don’t financial statements reflect your business’s true worth?
- Are financial statements used during a business appraisal?
- Why are adjustments necessary?
- What sorts of adjustments are made during the normalization process?
- Some of the most common adjustments made include:
- Adjustments to Financials Conclusion:
Seeking an appraisal of your business is beneficial for a variety of reasons. This benefit exists regardless of whether you plan to sell your company or transfer it to a family member. Knowing the actual value of a small business helps ensure that you, as a business owner, have the confidence needed to make the most appropriate decision for your company and business portfolio.
Please read what is a business valuation.
Although the internet provides access to online services that offer quick valuations, you should obtain a professional assessment. This is because a certified business valuation by an accredited Business Appraisal FL|GA|HI team member takes strategic and in-depth analysis to determine an accurate estimation of a company’s worth.
Since an accredited professional does the appraisal, adjustments to your business’s income statement or financial statements may occur. These adjustments, however, ensure that the valuation produced for your subject company accurately reflects its value. A CVA or similar accreditation can make the adjustments to the income statement needed for your company’s valuation.
Why don’t financial statements reflect your business’s true worth?
Many business owners may believe they can rely on their company’s financial statement when estimating their enterprise’s value. However, business owners should realize that financial statements alone cannot reflect the true value of a business. Your evaluator may need to make adjusting journal entries for unearned revenue, accrued expenses, officer compensation, and depreciation expenses as they make adjustments for your business appraisal.
This is because the accounting period statements do not reflect economic reality since they rely on accounting principles or tax regulations not designed with the market in mind. Additionally, bias may lead those who prepare financial statements for a company to exaggerate inputs that may skew interpretations of the business’s value.
Are financial statements used during a business appraisal?
Professional valuators, like those at BA FL|GA|HI, use financial statements strategically to assess a company’s value accurately. We will look at your revenues and expenses, your general ledger, and your business operations to see what best reflects the “truth” of your company.
To utilize the statements, the appraisers will first normalize them. After conducting the normalization process, the appraisers will have a better ability to compare the business in question to similar industries and companies.
Normalized financial statements also more accurately reflect the company’s actual earning capacity, which is crucial to understand business value.
Why are adjustments necessary?
Normalized adjustments, or valuation adjustments, restate financial statement values to the Fair Market Value (“FMV”). The FMV is the most common standard of value that valuators use to create an agreed-upon assessment for a business.
Normalization comes to be necessary when you’re selling a business because it helps more accurately reflect the true profitability or cash flow potential of the enterprise.
Without normalizing, a business’s financial statements could skew the value of the company because they may include personal or exaggerated expenses in the report.
What sorts of adjustments are made during the normalization process?
A variety of adjustments during the normalization process to facilitate the valuation of the business and give a true picture of operating cash flows.
Some of the most common adjustments made include:
- Related party transactions
Transactions between a company and its owners are often not made in a manner that reflects market standards. These transactions usually include compensation and property rented from a business owner.
Appraisers analyzing this data will often compare these figures to industry statistics, job market data, and commercial real estate rates. We then adjust the amounts of these transactions to reflect market rates.
- Discretionary expenses
We also remove expenses incurred as a result of the discretion of the business team members. Or reduce them to reflect industry standards better. These costs often include transactions in entertainment, travel, and charity, as well as expenses that primarily benefit the company owner.
- Non-recurring expenses
Many non-valuation professionals will argue that non-recurring expenses should not be adjusted for because such costs are legitimate. However, many business appraisal professionals tend to conduct adjustments of these expenses regardless of their legitimacy because such costs are very costly.
We will find assets on the balance sheet that needs adjustment made because they are excess assets or personal property. Most privately held businesses will need adjustments to the balance sheet.
As a result, without adjustments made, non-recurring expenses can significantly skew profitability and cash flow and lead to an undervaluation of the company.
- Owner’s Compensation
The final adjustment often made by professional valuators is the salary of an owner. This is because if the owner pays themselves an excessive wage, their company’s profits and cash flow will decrease. This will also lead to an undervaluation of the company.
Professional appraisers will determine an appropriate level of compensation for the owner based on the company’s size and revenue earned. The compensation may also be set based on experience.
Adjustments to Financials Conclusion:
BA FL|GA|HI appraisers have over twenty years of experience evaluating businesses in Florida, George, Tennessee, and beyond. Our experts rely on various methods, techniques, and adjustments to ensure that your business is accurately and effectively appraised.
Additionally, our accredited valuation analysts (AVA) are credentialed to perform business valuations that conform to Internal Revenue Service (IRS), American Institute of Certified Public Accountants (AICPA), and the National Association of Certified Valuation Analysts (NACVA) professional standards.
This unique combination of skills and experience provides an invaluable resource for all your business valuation and planning needs.
Reach out to our team today for a consultation. We are eager to help you reach your business goals.