Navigating Write Offs and Addbacks in the Process of Buying and Selling a Business

What impact on the bottom line profit and overall value of the business do write off have?

One of the commonly cited perks of owning a business is the ability to write off expenses and reduce the tax bill.

Write offs are fairly common for business owners, but they have an adverse affect on the bottom line profit of a business, which affects the overall Business Valuation for the business.  How does this happen?  Well, if  a business makes a true profit of $220,000, but only shows $100,000 in profit due to discretionary write offs, then it is clear to see that potential buyers are going to value the business for a lower number based on the profit of $100,000, because that is the number they see on paper.

The good news is that in many business valuation models, write-offs are adjusted for.  However, only standard add backs are typically adjusted for.  Interest expense, depreciation, owner salary are some examples of write offs that get adjusted for, which of course, depends entirely on which Business Valuation methodologies are employed.

The key is to avoid discretionary write offs that are not easily trackable or provable.  These write offs are not easily adjusted, if at all, which means that the value of the business is going to be reduced by this ‘hidden’ profit.

How much can one dollar of hidden profit affect a business valuation.  Possibly up to 5 or 7 times.  Meaning for each dollar of hidden, and unadjustable profit, the business could be losing $5 to $7 per on the valuation.

For example, if there are $10,000 of unadjustable profits in a business, it could reduce the value of a business by $50,000 to $70,000.

The question one has to ask, is do I want to reduce my taxes on an ongoing basis, or pay more in taxes and fetch a higher selling price for the business.  If you plant to sell in the next few years, you may end up with more cash at the end when you sell your business if you minimize the discretionary write-offs

For an analysis of your situation, contact our office for an appointment.  You can reach our Client Care Manager Sonia Chhabra at  (888) 926-9193 or email cs@justelementary.com for assistance with Business Valuation Matters