- Recast the historical financial statements to reflect the true profitability, cash flow and asset base of the business.
To determine the actual cash flow of a private business it is necessary to adjust the income statements for past efforts to minimize taxes and to provide extra benefit for the Owner. This adjustment is called recasting or normalizing the Profit and Loss Statement. It is particularly important for Buyers to understand the true discretionary cash available from the business.
Recasting entails adding back all Owners and family related expenses to income; those charges that would not be transferable to a New Owner. Expense categories to review for recast adjustments are:
- Above market salaries and fringe benefits
- Extra auto expense
- Travel & entertainment not necessary for business
- Unusual or one time expenses such as a large maintenance or repair expense that will not be duplicated
- Donations
- Extra Insurance
- Any other extraordinary expense that the New Owner would not have to bear after the sale.
Since these adjustments are material to the historical financial performance of the business they must be itemized in a well-documented schedule. The general rule is no paper trail, no credit to income.
Recasting the balance sheet is necessary when the transaction is structured as an asset sale. The book value of assets is rarely the market value. An effort should be made to obtain the fair market value of the assets, including any that may have been fully depreciated. Schedules should be included to provide the sources of information used for any adjustment from Book Value.
This development of recast financial statements is an important exercise for a business Owner.
(Recast Business Financial Statements)
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