What Are Addbacks And How Do They Affect Valuation?
Founders Investment Bank in Birmingham, Alabama, posts today about “addbacks”, the items and amounts that were previously charged to the Profit & Loss account but which can be added back to boost a company’s profit prior to putting it up for sale.
We’ve covered the calculation of EBITDA in several posts and here’s a more comprehesive piece on how accounts are recasted to show the real profit rather than the figure disclosed to government or tax authorities.
In founder or family-owned businesses, it is common for owners to run personal/non-company related revenue or expenses through the business or to expense certain items that would normally be capitalized. While these practices may come in handy during tax season, they can seriously impact a company’s valuation.
If you are a business owner considering an exit or recapitalization, we strongly recommend that you a) gain an understanding of what add-backs/adjustments are, b) understand how they impact valuation and c) begin the process of identifying and tracking them within your business.
Addbacks and adjustments come in many forms (typical items and examples are shown below), but generally they can be described as any item on the income statement that is non-core, one-time, or personal in nature. Put simply, addbacks and adjustments are items that should be “added back” to net income and/or zeroed out on the income statement due to one of the previously mentioned reasons.
Accounts from previous years can be recasted or normalised which involves processing the accounts again to have them reflect the true benefits enjoyed by the owners rather than the somewhat cut down version that businesses create (completely legally) to present to the tax man.
In the UK, as in most countries, there are numerous laws governing annual accounts and their proper presentation, but these laws apply only to those accounts presented to HMRC and/or Companies House. They don’t apply to calculations created for the purpose of demonstrating to a business buyer the real (and/or hidden) value in a company. Recasting the accounts, or recreating them for purposes of taking a business to market, is often done by the advisory firm assisting in the sale of the business. It’s an art form in itself as it needs to present the business in the best light while at the same time being completely credible and sound enough to face challenge from buyers.
More on how to do the recasting can be found here.