Normalising earnings: which add-backs a valuer accepts, and which it does not

What normalising earnings means

Most methods for valuing a small or medium private business start with earnings: what the business makes in a typical year. Reported profit is the starting point, but rarely the right number on its own, because owners make choices that suit them and their family. Some push profit down. Others push it up.

Normalising adjusts reported profit to the earnings a new owner could expect to keep making on ordinary commercial terms. Valuers call the result maintainable earnings. The adjustments are called add-backs, although some are deductions.

A buyer pays for the earnings the business will produce for them, not for the way the current owner arranged their affairs. The valuer strips out owner-specific items and genuine one-offs, and keeps what would carry over to someone else.

An add-back is a claim about the future, and it needs evidence from the past.

The three questions a valuer asks of every add-back

Owners often arrive with a list of add-backs, sometimes prepared by a broker or accountant. A valuer works through it line by line and asks the same three questions of each item.

1. 01Is it outside the ordinary running of the business?A cost that helps earn revenue stays in, however unusual it looks. A cost unrelated to earning revenue, such as the owner's private expenses, can come out.
2. 02Would a new owner avoid it, or need to pay something different?If a new owner would still face the cost, or a version of it, the add-back fails or is reduced. If they would pay more than the current owner does, the adjustment goes the other way.
3. 03Can it be proved?The amount must trace to the accounts, and the reason must be supported by a document such as an invoice, payroll record, lease or settlement deed. An explanation alone is not evidence.

An item that fails any one question is rejected or cut back to the part that can be supported.

Add-backs a valuer usually accepts

• Private expenses paid through the business: family holidays, school fees, private health cover, a family member's car. For mixed-use items only the private share comes out, and the valuer will want something that shows the split, such as a logbook.
• Genuine one-off costs: legal fees for a settled dispute, uninsured storm repairs, a one-time relocation or restructure.
• Owner pay above a market rate. The excess over what it would cost to employ someone in the role can be added back.
• Family members on the payroll who do little work. Their pay is added back, less the market cost of any real work they do.
• Related-party rent above market rent, where there is evidence of rent for comparable premises.
• Items outside trading altogether, such as a gain or loss on selling an old vehicle or investment income held in the business.

Add-backs a valuer usually rejects or reduces

These cause the most disagreement. Knowing the reason behind each is the quickest way to avoid a surprise in the report.

• Recurring "one-offs". If there is a major repair or legal matter in each of the last three years, a new owner should expect one next year too.
• Spending cut to lift profit. If marketing, maintenance or training was trimmed last year, the valuer may restore the normal level as a cost. The same applies to equipment overdue for replacement.
• Costs that earn revenue, even if they look personal, such as travel to a trade event where the owner meets key customers.
• Staff the owner says will not be replaced. If the role does real work, a new owner needs someone to do it.
• Savings that have not happened yet: a cheaper supplier under consideration, or a contract not yet signed.
• Income that is not in the records. Takings that were never recorded cannot be added back, and any question about them is one for your accountant and tax adviser, not your valuer.

Adjustments that reduce earnings

A careful valuer looks just as hard for costs missing from the accounts, because a buyer would have to pay them.

In many owner-run businesses the market wage adjustment is the largest single item, it usually reduces earnings, and it is the item owners most often leave off their list.

A worked example

The owner's figure reflects what the business produces for them, working the way they work. The valuer's figure reflects what it produces for someone else on commercial terms, which is what a market value rests on.

How to support your add-backs

Most rejected add-backs fail on evidence, not principle. A little preparation makes the process faster.

1. 01Build a scheduleList each adjustment with the amount, year, ledger account, a one-line reason and the supporting document.
2. 02Show three years, not oneGive the same detail for the prior two years, so a one-off can be shown to be one.
3. 03Keep the source documents togetherInvoices, deeds, payroll records, leases and logbooks come through the secure upload link on your matter, never by email.
4. 04Include the deductions tooNote unpaid work by the owner or family, below-market rent and business costs paid personally. It shows the schedule is balanced.

Why this matters for a valuation for tax

For tax purposes, market value is generally the price that would be agreed between a willing but not anxious buyer and seller. The ATO's guidance on market valuation says it generally judges a valuation by the process behind it: an objective, suitably experienced valuer, a recognised method and credible evidence. The ATO may review a valuation, and the taxpayer remains responsible for it.

Normalising adjustments are judgements, not figures copied from the accounts, so this is where evidence matters most.

This applies to a valuation as at 30 June 2027. Under the changes to capital gains tax that start on 1 July 2027, Australian resident individuals, and trusts with at least one eligible beneficiary, are generally treated as if they sold and reacquired relevant assets at market value just before that date. Some owners may use a valuation to work out that amount. Others may be able to use an apportioning method once one is made, and a company’s own post-CGT assets are outside this rule (pre-CGT assets have their own reset). Whether you need a valuation is a question for your tax adviser.

How Independent Business Valuation handles add-backs

At Independent Business Valuation, a suitably qualified business valuer at Valuo reviews every proposed adjustment and asks about anything the records do not explain. The report sets out each add-back and deduction, the amount accepted and the reason, so you and your accountant can follow it line by line. Guided by APES 225 Valuation Services.

We charge one fixed fee of $999 + GST for a full valuation report on one business or ownership interest with annual turnover under $10 million. The fixed fee applies once we confirm the interest, purpose, structure and records fit the fixed-fee scope. Anything outside it is quoted in writing before we start. Fixed fee, confirmed in writing before we start. No hourly billing and no surprises.