Normalized Earnings are adjustments made to the income statement in preparation to show potential buyers of the company. When making these adjustments, eliminate expenses not usually incurred for the production of the business. To show a more realistic return on investment, the normalized expenses should not appear on the future buyer’s income statement.
Different Types of Normalized Earnings
Type A: Non-Recurring Gains and/or Losses
The goal of “normalizing earnings” is to provide prospective buyers a typical income statement so they know what to expect. Expenses such as a lawsuit, non-operating assets, and other abnormal items that occur once are considered expenses you can eliminate when normalizing earnings.
Type B: Discretionary Expenses
Do not record certain expenses at fair market value price. Adjust these expenses so the buyer of a company does not assume these expenses incur regularly. If you include these expenses, then as the current company owners, you should specify that these expenses or earnings are not generating/generated by business. Examples include vacation homes, car rentals, start-up costs, and unreasonably high bonuses.
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Normalized Earnings Example
Type A: Laura experienced a lawsuit and lost $250,000. Because this was one-time event, remove the lawsuit expense for adjustment purposes.
Type B: Laura’s sales team had a sales contest to boost revenue for the year 15%. As a result, two salespeople gained extremely high bonuses totaling to a $100,000 additional salary.
By normalizing these earnings, EBITDA increases by $350,000, earnings that the buyer can potentially make without those extra costs.
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