M&A Terminology and definitions – Normalised profit
When discussing Business Value of small to medium businesses the term Normalised Profit is used.
Normalised Profit can be defined as the adjusted revenue and expenses to reflect the business as if someone else was running it.
Why do we need to do this? There are many reasons.
The main reason for adjusting the accounts is to remove activity that is extraneous to the business, or to adjust activity that is not accounted for at market value rates.
The most common adjustment related to shareholder salaries, as often shareholders pay themselves above or below market standard salaries depending upon their personal requirements and advice from external accountants.
Another area of discussion is related to revenue or expenses that are not related to the core operation of the business. This could be additional personal expenses, family employee expenses, or expense related to activities outside the core recruitment business such as funding a new business start-up.
Sometimes there may be legitimate once-off expenses in a business, such as legal costs for a contract dispute. However don’t rely on this too much to boost Normalised Profit as many once-off projects are in fact normal business operations and will be considered part of annual business expenses.
Related: It’s The Profit, Stupid
Sometimes a private business does not keep good accounts. Items may appear in the P&L that are wrong, like dividends or loans. Revenue and expenses may be categorised in a misleading or jumbled manner, making an assessment of revenue, gross profit and profit difficult. In this instance work will be undertaken to clarify the revenue and expenses so a fair assessment of value can be undertaken
HHMC is not advocating that legitimate personal and business activities are not undertaken. But our advice to smaller business owners is to run a clean and structured profit and loss statement in a manner that allows clear identification of non-business expenses. We certainly recommend that advice on how an external review of the P&L will be undertaken is sought. Participating in structured external benchmarking, such as offered by the RIB Report would be very beneficial.
Business owners do need to be realistic about presenting P&L adjustments (usually in the form of add backs) to a potential acquirer. An aggressive approach can be interpreted as unrealistic and greedy which does build trust for negotiations with a potential acquirer.
This article is part of a series related to M&A valuation in the current recruitment industry market. The series can be viewed here.
HHMC Global provides advisory services to the recruitment and staffing industry and is best known for its work on M&A transactions. HHMC is based in Australia and works with clients globally. To discuss your business future contact Rod Hore or Richard Hayward.