How owner salaries and one-off expenses affect business value

By Evident Valuations

Reported profit is an important starting point for a business valuation, but it may not describe the earnings the business can sustain. An owner’s pay, related-party arrangements and unusual events can all affect the reported result.

Normalising earnings means examining those differences and making supported adjustments for the valuation’s purpose and assumptions. It is not a process of removing every expense an owner would prefer a buyer to ignore.

An owner’s salary pays for work as well as ownership

Identify what the owner actually does: sales, clinical or technical work, management, administration or several roles. Consider the resources needed to perform those tasks if the owner leaves.

If an owner is paid above a supported replacement cost, an upward adjustment to earnings may be appropriate. If the owner is underpaid, the necessary adjustment may reduce earnings. Replacement cost should consider the role, time commitment and relevant employment on-costs on a consistent basis.

Simply adding back the owner’s entire salary while retaining all the revenue generated by their work can leave a misleading picture of profitability. A buyer who intends to do that work personally still needs to distinguish a return for labour from a return on ownership.

A worked earnings example

Consider a hypothetical business reporting EBITDA of $400,000, after deducting total owner employment costs of $220,000. Suppose the analysis supports a like-for-like replacement cost of $160,000. Also assume a $25,000 expense included in EBITDA will not recur, while $15,000 of income included in EBITDA is non-recurring.

• Reported EBITDA: $400,000
• Owner employment cost adjustment: +$60,000
• Supported non-recurring expense adjustment: +$25,000
• Remove non-recurring income: −$15,000
• Illustrative adjusted EBITDA: $470,000

This example explains the arithmetic only. The amounts, replacement role and non-recurring treatment are assumed, not market benchmarks. It does not establish a valuation multiple or the value of any actual business.

When is an expense really one-off?

Investigate why the cost arose and whether a similar cost is reasonably expected again. An expense described as exceptional every year may be part of the business’s ongoing risk and operating pattern.

A useful test is to compare the explanation with several periods of financial records and the outlook. If last year’s unusual repair is removed, consider whether future maintenance or replacement investment still needs to be allowed for. Costs do not disappear merely because their timing is uneven.

Apply the same discipline to income. An unusual receipt can inflate reported earnings just as an unusual expense can reduce them. Adjustments should be balanced, rather than designed to reach a preferred number.

Keep a clear adjustment schedule

For each proposed adjustment, record the amount, accounting period, ledger reference, explanation and supporting evidence. Show whether it affects EBITDA, another earnings measure or cash flow. Explain any associated replacement expense.

For example, a related-party rent adjustment needs evidence of the premises and terms being compared. An owner expense adjustment needs a clear explanation of whether the expense supports the business. The description in the ledger alone may not resolve the question.

Adjusted earnings are one part of value

A better-supported earnings figure does not by itself settle the appropriate multiple, growth assumptions, risk assessment or required investment. EBITDA also leaves out items such as capital expenditure and working-capital movements, so it should not be confused with cash available to owners.

The adjustments and valuation method must fit together. Read our guide to valuation methods and the enterprise-to-equity value example for the next steps in the analysis.

To discuss the financial information and owner involvement in your business, explore business and share valuations or contact Evident Valuations.

Technical reference

The International Valuation Standards, IVS 200 discuss business interests, financial measures and valuation adjustments. The worked example above is illustrative and uses its own stated assumptions.

Related reading

• Enterprise value vs equity value: a worked example
• Valuing a dental practice: what information matters?

General information only. The appropriate valuation approach and requirements depend on the circumstances, agreed scope and intended use. This article is not a valuation of a particular business or individual legal, tax or financial advice.

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