What is Unreported Income?
The Short Answer
Unreported Income explained simply
Unreported income is money a business earns but does not declare to tax authorities. This often happens in cash-heavy businesses where transactions are not always recorded. While illegal for tax purposes, this income is real and contributes to the business’s actual profitability. When valuing a business, especially a small one, buyers and brokers often look for this unreported income. They add it back to the reported profits to get a truer sense of the business’s earning power. This adjustment helps in determining a fair market value.
Real-World Example
The Cash-Only Cafe
Imagine a small cafe that primarily deals in cash. The owner reports $100,000 in annual profit to the IRS. However, the owner also pockets an extra $30,000 in cash sales each year that is never reported. When a buyer looks at this cafe, they will adjust the reported profit. They will add the $30,000 of unreported income back to the $100,000 reported profit. This means the business is valued based on $130,000 in actual earnings, not just the $100,000 on paper.
Why this matters
Unreported income matters because it directly impacts a business’s true profitability and, therefore, its value. For sellers, accurately disclosing this income (even if it was unreported) can lead to a higher sale price. For buyers, understanding how to identify and account for unreported income helps them assess the real earning potential of a business. It ensures they are not underestimating the business’s worth based solely on tax returns.
When selling, be honest about unreported income. Buyers will find it during due diligence. It’s better to disclose it upfront and explain how it contributes to the business’s real value.
When selling, be honest about unreported income. Buyers will find it during due diligence. It’s better to disclose it upfront and explain how it contributes to the business’s real value.
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