What are the most common normalizations?
The year is over and the annual reports are being drawn up again. However, one should know that these annual reports can be influenced to some extent. With an acquisition or sale these reports are therefore critically examined. It sometimes happens that costs or expenses are made that are not directly applicable to the business. Therefore, an acquisition advisor first looks at the costs or expenses that are normally not applicable before the figures are shared with potential buyers. These often non-recurring expenses reduce the operating result (the so-called Earnings Before Interest Tax Depreciation and Amortisation, orEBITDA for short). This in turn has a negative effect on the valuation of the company if we assume a valuation based on multiples. To get an accurate picture of the company, these costs should be "normalized".
Below are the most common normalizations used:
- Non-arms-length revenue or expense
This refers to intercompany cash flows. For example, purchasing costs that are lower because they were obtained at a discount from a sister or subsidiary company. In this case no fair-market price has been paid. In this case the purchase costs must be estimated higher. Transactions between subsidiaries must be at arm's length.
- Management remuneration
The remuneration of the DGA is often either higher or lower than the regular salary of a regular manager. In the start-up phase it is usually lower to save costs and then later on to pay a higher remuneration. In addition, the DGA can have a bonus paid on top of his salary. This compensation must therefore be corrected to the level when a manager is directing the company. It is important to find the right benchmark.
Not every company owns the real estate. It often leases business space from third parties. In some cases it rents it from the holding company. When renting from a holding company, there is often a discount agreed upon in the rent. As in point 1, often no fair-market price is paid for this and a correction will have to take place. Point of attention in the transaction is the position of the real estate, is this also sold or not.
- Litigation and Disputes
Fees or expenses from legal disputes may be deducted from or added to EBITDA as non-recurring expenses.
- One-time advisory costs
These are the costs that arise, for example, when hiring a lawyer for legal disputes. However, also the costs of the advisor who guides the entrepreneur in selling his business.
- Repairs and Maintenance
A category that is often forgotten is repairs and maintenance. It is important to see the relationship with necessary investments and/or overdue maintenance. Here the disadvantage is that this does have a negative effect on the valuation.
- Other Income and Expenses
This category is also often full of items that can be normalized. Any item that is not recurring can be normalized.
Taking a critical look at regular and one-off costs in the run-up to a possible sale can certainly pay off.Hans Minnaar - Managing Director @ Florijnz