What are Add-backs?
The Short Answer
Add-backs explained simply
When you look at a business’s financial statements, you’ll see its net income. But for a buyer, this number doesn’t always show the full picture of how much money they could make. That’s where add-backs come in.
Add-backs are expenses that a current owner incurs that a new owner might not. These can be personal expenses run through the business, one-time costs, or non-operating expenses. By adding these back to the net income, you get a clearer view of the business’s true earning power. This adjusted profit figure is often called Seller's Discretionary Earnings (SDE) or Adjusted EBITDA.
Real-World Example
The Coffee Shop Scenario
Imagine a coffee shop with a net income of $80,000. The owner pays themselves a salary of $50,000, which is an add-back. They also have a one-time expense of $5,000 for a new espresso machine, which is also an add-back.
To calculate the adjusted profit, you would add these back to the net income:
$80,000 (Net Income) + $50,000 (Owner Salary) + $5,000 (Espresso Machine) = $135,000 (Adjusted Profit/SDE)
This $135,000 is a more accurate representation of what a new owner could potentially earn from the business.
Why this matters
Add-backs are important because they help buyers understand the real profitability of a business. Without them, a business might look less profitable than it actually is. This can lead to a lower valuation and a missed opportunity for both the buyer and the seller. They help level the playing field and ensure a fair valuation.
Always ask for a detailed list of add-backs and be ready to explain each one. Buyers will scrutinize these, so clarity is key.
Always ask for a detailed list of add-backs and be ready to explain each one. Buyers will scrutinize these, so clarity is key.
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