What does normalising earnings mean?
Reported profit is shaped by how an owner chooses to run the agency and pay themselves, not by what a buyer will earn. Normalising adjusts the profit and loss, usually for the last three years and the current year, to the figure a buyer could expect to keep earning: maintainable earnings.
The ATO's guide to market valuation describes the income approach and the capitalisation of earnings method, and lists common problems that normalising is meant to prevent, including unreasonable or incorrect assumptions and inputs, inappropriate use of averaging, and lack of appropriate analysis and scrutiny of base information.
How is the owner's salary adjusted?
Principals are often paid through drawings, dividends or trust distributions, or at a salary that bears no relation to their work. A valuer replaces whatever the owner takes with the cost of employing someone to do the role they actually perform, plus superannuation: a sales manager and lead agent in a real estate agency, an account director in a marketing agency, a senior broker in a mortgage broking business, a lead consultant in a recruitment agency. Where two principals work in the business, each is costed separately.
Family members need the same treatment. A spouse on the payroll who does not work in the agency is added back. One who runs the rent roll or the books unpaid is a cost a buyer will have to meet, so a market wage is deducted.
How is related-party rent treated?
Many agencies rent their office from the principal's family trust or self-managed super fund. If the rent is above market, the excess is added back; if it is below market, a buyer leasing the premises on ordinary terms would pay more, so the difference is deducted. The evidence is the lease and a market rent opinion from a property valuer or leasing agent. We value businesses, not property, so we rely on that evidence rather than giving a rent opinion ourselves.
Which one-off items are removed?
One-off items are taken out in both directions:
- ·Gains on selling a portion of a rent roll, book or client list, which will not recur
- ·Legal costs of a dispute that has ended, or recruitment costs for a role now filled
- ·One-off government grants, insurance recoveries or a single unusually large project
- ·The owner's private costs run through the business, such as a private vehicle, family phones or personal travel
- ·Restructure, relocation or system changeover costs that will not repeat
- ·In the other direction: deferred spending a buyer will have to make, such as overdue software or a vacant role that must be filled
How are staff costs normalised?
Staff costs are adjusted to the level the agency needs to keep producing its revenue. A rent roll run by stretched property managers looks cheap to service today and carries a resignation risk tomorrow. A recruitment agency paying a top consultant well below their billings may face a pay rise or a departure after the sale. Where contractors do work an employee would do, or bonuses and sales splits are paid informally, the valuer adjusts to what a buyer would really pay.
Hypothetical illustration: from reported profit to maintainable earnings
Invented figures for one year of a hypothetical real estate agency, not market data. Here the normalised figure is well below reported profit; in another agency the adjustments could run the other way.
| Item | Amount |
|---|---|
| Reported profit before tax | $420,000 |
| Add: principal's private vehicle and phones paid by the agency | +$18,000 |
| Add: legal costs of a concluded dispute | +$35,000 |
| Add: rent above market paid to the principal's family trust | +$24,000 |
| Less: market salary and super for the principal's role, now paid by distributions | -$160,000 |
| Less: market wage for rent roll work done unpaid by a family member | -$70,000 |
| Normalised earnings before interest and tax | $267,000 |
What evidence does each add-back need?
An add-back without evidence is an assertion. The ATO says the onus for a replicable and defensible valuation remains with the taxpayer even when a professional prepares it, and a buyer's accountant will test every line. For each adjustment, expect to provide:
- ·General ledger detail for each account adjusted, for each year
- ·Invoices or statements for one-off items, with a short note on why they will not recur
- ·Payroll reports and a list of who does which role, including family members
- ·The premises lease and any market rent opinion
- ·How each working owner is paid: salary, super, drawings, dividends or distributions
What does an agency valuation cost?
Normalisation is included in every valuation we prepare, and the fee is fixed in writing before work starts. The band is set by the annual revenue, excluding GST, of what is valued: a rent roll's annual management income, an insurance or mortgage book's annual recurring income, or the agency's total annual turnover where the whole agency or shares or units in it are valued. Delivery time starts once payment and all required information have been received.
- ·Small Business Valuation: $1,495 + GST where the revenue of what is valued is under $2 million, delivered in 2 business days
- ·Medium Business Valuation: $2,495 + GST from $2 million to $3 million, delivered in 3 business days
- ·Large Business Valuation: $3,495 + GST above $3 million up to $10 million, delivered in 3 business days
- ·Above $10 million: quoted in writing before work starts, with the delivery date agreed before commencement
- ·Expert report for a dispute or court: $4,495 + GST, with the delivery date agreed before commencement
- ·Add-ons: +$495 per retrospective (past) valuation date and +$795 per additional entity