Before you start
- An add-back is not automatically valid because it appears in a seller’s schedule.
- Normalisation should consider both expenses removed and costs that need to be introduced.
- Adjustments should be supported by records and applied consistently across periods.
- The selected multiple and earnings base must be considered together.
From reported profit to maintainable earnings
Financial statements are prepared for accounting and tax purposes, not solely for valuation. In an owner-managed business, the accounts may include personal or discretionary expenses, non-market owner remuneration, related-party arrangements and one-off events.
A valuation analysis reviews these items to estimate a normal level of earnings. The goal is not to produce the highest possible profit. It is to form a supportable view of what the business can reasonably continue to earn after allowing for the resources needed to operate it.
Examples of adjustments that may be considered
Whether an adjustment is appropriate depends on the facts and evidence. Common areas for review include:
- Owner wages and superannuation compared with a market-rate replacement role
- Private or discretionary expenses that are not required for operations
- One-off legal, relocation, repair or project costs
- Non-recurring grants, insurance recoveries or unusual income
- Related-party rent or service charges compared with commercial terms
- Costs omitted from the accounts but required under independent ownership
Why some claimed add-backs are rejected
A claimed expense may look discretionary but still be necessary to maintain revenue. Marketing, travel, vehicles, training, software and family wages are common examples where the label alone does not settle the question.
An adjustment is more persuasive when the reason is clear, the amount reconciles to the accounts and the expense will not recur in another form.
A worked example: adjustments can reduce earnings
The following fictional example starts with reported EBITDA, meaning earnings before interest, tax, depreciation and amortisation. All amounts are annual. It assumes the listed expenses and income are already included in that starting figure.
| Item | Adjustment | Running total |
|---|---|---|
| Reported EBITDA | Starting figure | $300,000 |
| Private holiday, evidenced and unrelated to operations | +$8,000 | $308,000 |
| Legal cost for a completed, non-recurring matter | +$12,000 | $320,000 |
| One-off grant included in reported income | -$20,000 | $300,000 |
| Owner’s recorded employment cost of $80,000; replacement cost of $140,000 | -$60,000 | $240,000 |
| Related-party rent of $30,000; assumed commercial rent of $45,000 | -$15,000 | $225,000 |
The result is $225,000, not $320,000. Removing unusual expenses is only half the job. Missing operating costs and unusual income matter too.
Owner remuneration needs special care
If an owner works full-time in the business, simply adding back all owner wages can overstate earnings. A buyer may still need someone to perform management, technical, sales or administrative duties.
List the owner’s weekly tasks before choosing a replacement salary. Someone quoting jobs, supervising staff and doing technical work might need more than one person to replace them. Include superannuation and other relevant employment costs on a consistent basis when comparing actual and replacement remuneration.
Seller’s discretionary earnings can use a different basis that includes the benefit available to one working owner. Label that measure clearly. It cannot be compared directly with EBITDA after paying a replacement manager, or multiplied by a multiple derived from that different earnings measure.
The four tests for an add-back
For each proposed adjustment, keep a short note that answers these questions. If the answer is unclear, flag it for discussion instead of quietly including it in the total.
- Is it in the starting earnings figure? An item cannot be added back twice.
- Can the amount be traced to the ledger, invoice or payroll records?
- Why would the cost or income stop under the assumed future ownership?
- Would another cost replace it, such as a manager, vehicle or software subscription?
Consistency across years matters
Looking at a single year can hide volatility or unusual conditions. A multi-year review helps identify trends, margin changes, recurring adjustments and whether recent results are representative.
Where trading has changed materially, the valuation should explain how much weight is placed on historical, current and forecast performance. Forecasts can be informative, but their assumptions and track record need to be tested rather than accepted at face value.
Sources and further reading
The examples in this guide are illustrative. These references explain the underlying principles and offer further practical guidance.
- ICAEW: Completion mechanisms
Professional guidance explaining normalised EBITDA, enterprise value and completion adjustments. It is UK transaction guidance, used here for valuation mechanics rather than Australian law.
- Business Queensland: Valuing a business to buy or sell
Explains why the owner’s work needs a fair salary allowance, including superannuation, when assessing the return from a business.
General information for Australian business owners. A valuation depends on the business, valuation date, purpose and evidence. Seek advice on your circumstances before a transaction or ownership change.
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