The Art of Business Valuation

CHAPTER 5Normalization of Cash Flows

Any cash flow that is measured in business can be used to compare the company being valued to the comparison set. These can include revenues, gross profit margin, operating income, after tax profit, and others. The most common comparison sets for small and very small businesses are revenues, earnings before interest, taxes, depreciation, or amortization (EBITDA), and seller's discretionary earnings (SDE).

NORMALIZATION OF FINANCIAL INFORMATION

Financial statements must be adjusted in order to create comparable information. Every business owner, bookkeeper, and accountant keeps financial records differently. Yet the basis for estimating a value is to compare THIS company's facts, circumstances, records and results with OTHER companies. Through comparison, the analyst estimates a value. Therefore, it is important to convert the financial information provided into comparable data. Basically, ensuring apples to apples comparisons. This process is described as normalizing or adjusting the financial records.

This chapter addresses adjustments made specifically for use in valuing various cash flows and not cleaning up the financial data. Adjustments to locate more workable starting point financial statements are covered later in Chapter 11, Accounting Issues with Small and Very Small Businesses.

The primary categories of normalization adjustments are comparability adjustments, non-operating or nonrecurring adjustments, and discretionary adjustments. ...