“Add-Backs” and How They Impact Business Value
Steve Mize, ASA September 1, 2020
One of the most challenging aspects of valuing a small business is the use of Income Statement Adjustments, otherwise known as “add-backs”. For smaller businesses add-backs are common, but can they be verified?
Add-Backs - The Questions We're Asking
• Can the expense being added back be traced back to the source document's Income Statement (P&L or Tax Return) . If not, it can't be used.
• Does the expense have any impact on revenue or efficiency? Expenses directly related to generating revenue or improving cash flow, are not considered as add-backs.
• Is the add-back strategic in nature or directly related to a particular buyer? Add-backs specific to the buyer / buyer’s company are considered strategic and cannot be used in determining Fair Market Value.
• Is the add-back truly non-recurring or “one time”? This can be speculative but at GCF we follow a simple rule, if the expense was unexpected and will never occur again we will consider it.
Supporting the Add-Back
- Identify the actual amount that was expensed on the tax return or financial statement being used as the source document.
- Identify where the expense can be found.
- If the item is part of a larger expense category, generate a General Ledger Report (CPA or who ever prepares the financial data) that provides the detail of each expense under that category highlighting the add-back being used
- Explain why this expense will not continue with the sale.
Do Add-backs Impact Value
Yes they do. Add-backs contribute to financial risk, so the more of them there are, the more risk there is which is unfavorable to value. It's best to eliminate as many, if not all, discretionary add-backs to maximize value. If they cannon be eliminated, document them with as much detail as possible. Using the guideline above, lenders are likely to accept them.