In the process of preparing financial statements for tax filing, the objective is typically to minimize taxable income, aiming to convey to the IRS that the business has earned as little profit as possible. However, in the context of business valuation, the goal shifts towards portraying the highest possible earnings to potential buyers. Resolving this inherent conflict is a practice commonly known as "recasting."

Recasting involves a meticulous adjustment of expenses incurred by the business that may not directly contribute to its core operations. These adjustments encompass a spectrum of factors, including personal expenses charged through the business, discontinued operations, inflated compensations, among others.

It's essential to recognize that while a business may incur certain expenses, it doesn't necessarily imply that a prospective buyer will inherit all of them post-acquisition. Many of these expenses can be deemed discretionary and consequently added back to bolster the bottom line. This recalculated figure, often referred to as Seller’s Discretionary Earnings (SDE) or Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), serves as a more accurate representation of the business's profitability for potential buyers, surpassing the figure reported to tax authorities.

It's a common scenario for businesses to optimize their tax deductions, albeit inadvertently compromising their overall business valuation in the process.

Hence, engaging our services for meticulous bookkeeping as you approach a potential exit proves advantageous. We specialize in leveraging your financial reporting to achieve dual objectives: maximizing tax efficiency while concurrently mitigating adverse impacts on your business valuation.

The valuation of your business is derived from a multiplier applied to its Seller's Discretionary Earnings (SDE) or Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). For instance, if your SDE stands at $100 and the business is assessed at a multiple of 4, the resultant valuation would be $400 ($100 multiplied by 4).

However, a common error among business proprietors is the presumption that the business's value is equal to this calculated sum plus the value of their assets. This assumption is wrong, and here's the rationale:

Assets within your possession, such as equipment, are instrumental in generating cash flows. Drawing from the aforementioned example, all assets contribute collectively to the production of a $100 cash flow (or SDE). Therefore, if a purchaser is paying for the business based on its earning potential, it logically ensues that they keep the associated assets responsible for generating the $100.

Consequently, irrespective of the assessed fair market value of the assets, be it $20, $350, or any figure in between, the cash flow valuation of the business remains consistent at $400.

Business owners often perceive their business through the lens of its potential rather than its current state, which can lead to unrealistic expectations during the sale process. While they may believe that emphasizing future possibilities will increase the sale price, buyers assess businesses based on past performance and tangible results, not hypothetical potentials.

Business valuations predominantly rely on objective data such as earnings and industry multiples. Despite this, there's a subjective element to valuation, particularly in the range of multiples applied. Factors like established systems, effective management, customer diversity, and market popularity influence where a business falls within this range.

While subjective factors can enhance valuation, they must align with reasonable expectations. Ultimately, buyers are driven by the tangible value a business presents, not just its perceived potential.