There are many versions and definitions of profit. Business buyers need to be aware of the subtle differences in terminology used to describe profit, so that they can understand the impact and implications of these differences.
Some of the different methods used in reporting profit are:
- Owner Operator. The pre-tax return earned by a working owner – includes the owner’s wages.
- EBIT. Earnings Before Interest & Tax. Does not include owner’s wages.
- PEBIT. Proprietors Earnings Before Interest & Tax. Includes owner’s wages.
- EBITDA. Earnings Before Interest, Tax & Depreciation Allowance. Does not include owner’s wages.
- PEBITDA. Proprietors Earnings Before Interest, Tax & Depreciation Allowance. Includes owner’s wages.
- After Tax Profit. The profit after adjustment, and after paying company tax. Used by publicly listed companies.
- Adjusted Nett. The Profit after adjusting for abnormal or personal expenses and income.
- Annualised Nett. The profit calculated by taking a part-year’s profit, and dividing by the number of months, then multiplying by twelve to estimate a year’s result.
Every business is run differently to suit the individual needs and requirements of the owners and shareholders. So what is nett profit?
In order to accurately compare one business with another it is necessary to make adjustments to the income and expenses. These adjustments are often referred to as “add-backs” or the adjustments are sometimes known as “recasting”.
On the income side, the type of adjustments that are made are; exclusion of interest received, exclusion of profit on sale of assets, and sometimes the correction of opening or closing stocks.
On the expense side there can be many expense items shown in the financial accounts simply to minimise tax. Such items often adjusted are; accountancy, interest, depreciation (debatable), personal phone, motor vehicle, owners wages, or owner’s family member wages, some taxes, and some rebates.
It is essential (when looking at a set of accounts), that all adjustments are shown and itemised. Often these add-backs are not itemised, and it is important to look carefully at these numbers to ensure their source, and to confirm their relevance to how a buyer would operate the business.
A buyer should be starting to calculate what would they believe the real profit is. The expression of profit can be a subjective matter, rather than fact. A buyer’s ability to understand the accounts presented to them, and to determine what they believe the profitability is, will form the basis of their plans for the business, its growth, and their management of the business.
Banks lend on the past profits, or historic accounts of the business, yet it’s the future profits that are going to repay the bank that loan. It needs to be recognised that the historic figures are the proven results of the business’s trading, and the future is unproven. It is therefore wise to prepare both historic accounts and forecasts, and to use both of these tools to analyse and assess the business. Both the past and the future trading needs to be assessed when considering a business acquisition.
It’s also wise to remember that any business is more than just numbers, and profits. Obviously profit is essential, but small business owners must have a passion for the business and really enjoy what they’re doing.
Business buyers should look for a business that they will be proud of – one that rewards them in more ways than simply the financial returns.