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When we are valuing a company and are presented with financial statements, typically we ask the owner questions regarding their business operations. We try to obtain information beyond financial data so we can normalize certain financial statement items to use in the valuation.
For example, if we were to value a company using an income approach (assuming we have determined that an income approach would be the most appropriate in the valuation of the company), we start by taking the income before taxes figure from the financial statements. Next, we add back any interest expense and amortizations to arrive at earnings before interest, taxes, depreciation and amortization (“EBITDA”) for each year, or alternatively, add back interest expense to arrive at earnings before interest and tax (“EBIT”). After determining EBITDA (or EBIT), we factor in normalization items to determine a “normal” level of business operations. Some normalization items include:
The above list is not exhaustive but provides examples of some things that we consider in the valuation of a business. After normalizing certain items from EBITDA (or EBIT), we arrive at a normalized figure that will then be used in deriving a value of the company.