Determining the value of a business is often a complex task and is best done by either a VR professional intermediary, or a qualified business valuation analyst. Before one can determine the market value of a business, the financial information (profit & loss statements, balance sheet, and tax returns) must be recast to reflect the true earning power of a privately held business.

 

The recasting of financial statements provides buyers with a common baseline, Discretionary Earnings (DE), to compare earnings from different businesses and calculate the potential earnings after acquisition.

 

Focus on what your company is really worth. Prospective buyers are interested in companies that have value to them. Therefore it is important to have a current and accurate valuation done on your business before the process of taking it to market begins.

 

Recasting Financial Statements:

 

Small and mid-market businesses, in contrast to large public and private corporations, tend to keep reported net income as low as possible to minimize their taxes. Recasting of financial statements is a critical tool in presenting the real earnings history of the business to prospective buyers and also to arrive at an accurate value for the enterprise. The recast financial history and Discretionary Earnings (DE) takes into consideration and eliminates expenses that are owner benefits, nonrecurring, or nonoperational to calculate the total economic benefit the owner realizes from the enterprise.

 

Recast financial statements provide buyers with a common baseline, DE, to compare earnings from different businesses to each other as well as a way to calculate their potential earnings after they have purchased the business. Once the financials are recast your VR Intermediary will prepare a market value analysis to determine the market value of your business.

 

What is Discretionary Earnings (DE)?

 

Discretionary Earnings (DE) is a measure of the total financial benefit accruing to the owner of a business. DE is the most common measure of earnings used a for small and mid-size privately held businesses because it is the most accurate way to reflect the total economic benefit for the owner. Below is a simplified explanation of how DE is calculated. While this looks relatively straightforward, many other factors must be considered when recasting a financial statement. Recasting a financial statement requires extensive training and experience. Your VR Professional Intermediary has had extensive training on recasting financial statements and business valuation.   

DE is calculated as follows (simplified):

 

+ Pre Tax Net income (from tax return)

+ Owner's salary

+ "Discretionary expenses" or perks

+ Non-cash expenses (e.g. amortization & depreciation)

+ Interest expense

+ Non-operating expenses

+ Non-recurring or one time expenses

_________________________________ 

 

= DE (Discretionary Earnings)  

 

Earnings Before Interest Taxes Depreciation & Amortization

 

EBITDA is also a measure of earnings and is the most common measure of earnings used for large corporations (e.g. Wall Street). While EBITDA does add back Ø pre-tax earnings with interest, depreciation, and amortization expenses added back, it does not add back any owner benefits such as owner's salary and perks which are typically expensed to a small and mid-size business. EBITDA is an excellent earnings measure for large professionally managed corporations where the professional management team is operating the company and no owner benefits are expensed through the company. When EBITDA is applied to a small company the figure does not accurately reflect the total economic benefit of the company as the owner economic benefit is left out. For this reason DE is the more common earnings measure for small companies and EBITDA is more common for large companies with full time professional management operating the company.