What is the adjustment trying to measure?
Define the measure first. Net income, SDE, EBITDA, adjusted EBITDA, and cash for debt payments answer different questions. A change suitable for one may mislead in another. State what the result measures before carrying adjustments from a seller schedule into the buyer's model.
The valuation hub and Four-Number Plumbing Valuation Screen separate those measures. Put period, accounting basis, and buyer role at the top. Keep them fixed through each comparison so a larger number does not hide a change in work or cost assumptions.
Discretionary starts a review. It does not prove amount, period, disappearance, or replacement needs. Answer each question. A payment may be personal in part while including something the company still uses. The schedule needs the supported component rather than the label alone.
Which records should support each proposed add-back?
Find ledger entry, invoice, payroll, payment, period, and explanation. Match the amount to statements. If only part is claimed, show its calculation. Keep the record and reasoning together so the reviewer can trace the proposed change back to an expense actually included.
IRS Publication 583 describes support for income, expenses, and assets. Use underlying evidence. Tax returns may confirm totals without showing enough detail for each adjustment. Obtain the needed records instead of treating a reported total as proof that every proposed expense removal is supported.
Keep originals available through agreed access. A rounded presentation number does not become accepted because several files repeat it. Mark proposed, supported, disputed, or reviewer-accepted status. Date the finding so later changes do not obscure which amount and operating assumption were actually reviewed.
| Adjustment claim | Evidence to examine | Buyer-side question |
|---|---|---|
| Owner compensation | Payroll and actual duties | What work needs replacement? |
| Claimed personal spending | Invoice, purpose, and recorded amount | Does this component disappear? |
| Unusual legal or project cost | Matter, timing, and recurrence | Is the expense truly outside ongoing operations? |
| Related-party occupancy | Agreement and appropriate rent support | What occupancy cost continues? |
| Depreciation | Asset records and chosen earnings definition | What maintenance and capital cash still matter? |
| Omitted expense | Supporting obligation and timing | Does earnings need a downward adjustment? |
How should owner compensation be handled?
List real owner duties: field work, estimates, dispatch, hiring, finance, management, customer ties, and regulated oversight. Which does the buyer perform, and which need someone else? Compare time and capacity. A salary line does not capture every role or show what replacement will cost.
Owner pay may be removed in a stated working-owner measure. A managed model still needs paid capacity for required roles. Do not delete the full salary when someone must perform the work. Show the replacement in the same case as the compensation change.
The quality-of-earnings guide connects earnings to continuing operations. A working buyer, investor, and existing trade firm may staff differently. Present explicit cases. One party's plan does not make its adjustment correct for every buyer or show that the same earnings transfer under another model.
Confirm duties and availability as well as pay. A hypothetical salary does not prove someone qualified can be hired on those terms. Keep the dependency visible until supported. The price model should not treat a budgeted replacement as completed recruitment or approved operating authority.
What makes an expense truly nonrecurring?
What caused the expense, does the need continue, and does similar spending recur? A unique event may be unusual. Repeated one-time repairs or legal bills may be an ongoing burden. Review the underlying work rather than relying only on the account's name.
Compare several periods and seller explanations. Separate deal fees from ordinary annual adviser fees. Check prior exclusions and reimbursements. An item cannot be removed twice. Keep the actual cost and period clear before claiming that its absence improves the earnings the buyer can retain.
IRS Publication 538 addresses tax accounting timing. A cash expense appearing once may cover a recurring longer period. An unpaid duty may need buyer cash despite absence from cash-basis costs. Reconcile timing before deciding the expense is exceptional or that the need disappears.
How does a hypothetical adjustment bridge work?
Take a hypothetical managed planning case. Reported earnings are $120,000 after $100,000 owner pay. Assume an $80,000 replacement role, $6,000 of costs that end, and $8,000 truly nonrecurring. These invented inputs define the exercise rather than a real company's results or local replacement-pay benchmark.
The bridge is $120,000 + $100,000 − $80,000 + $6,000 + $8,000 = $154,000. It is a planning earnings bridge under those assumptions. It does not establish EBITDA, lender acceptance, or a completed review. State the chosen measure before using the output in any pricing calculation.
Higher replacement cost changes the result. If the $8,000 recurs or never entered reported earnings, that adjustment changes too. Document these dependencies. Correct arithmetic cannot make uncertain inputs verified, so retain the case assumptions with the result rather than reporting only the improved total.
The multiples guide links earnings to the pricing convention. An inconsistent base is not fixed by a conservative-looking ratio. Settle the measure and costs before comparing matching denominators.
What happens to depreciation, interest, and capital needs?
IRS Publication 946 describes depreciation as cost recovery. It does not decide condition, market value, or future replacement. A fully depreciated truck may still work or need repairs. Use service records and inspection for those findings instead of inferring them from tax history.
Adding depreciation does not pay for repairs or vehicles. Show maintenance, capital, leases, and other cash separately. Avoid counting the same repair as recurring expense and one-time deduction without a supported difference. The model needs consistent cost treatment alongside the chosen earnings definition.
Interest treatment follows measure and structure. Adding past interest to a metric does not remove acquisition debt payments. Show proposed loan payments separately in repayment and cash review. Compare the actual funding plan so the earnings adjustment is not mistaken for money left after borrowing costs.
The working-capital guide connects closing balances and duties. Adjusted earnings differ from spendable cash or proceeds. Keep each schedule's purpose clear.
Which downward adjustments are easy to miss?
Look for necessary omitted costs: managers, qualifying supervision, occupancy, insurance, recurring software, and customer service promises. Use the buyer's actual plan. These may require downward changes rather than additions. Identify work and support so the review does not focus only on items that raise earnings.
These are review questions, not findings for every target. Support actual amounts with records. Keep a buyer's optional upgrade apart from necessary operating cost. A preferred system or extra employee is not automatically a cost the company must bear to sustain the earnings being analyzed.
Review related-party charges with advisers. Above- or below-market amounts may need changes in either direction. Obtain support for continuing terms. The goal is a defensible operation, not the largest add-back sum. Retain real occupancy and work costs when normalizing how they were historically charged.
What does current lender review require?
Current SBA SOP 50 10 8.1 requires lender analysis and justification for cash-flow adjustments. Specified QoE rules concern recurring arm's-length earnings and independent lender-benefit review in applicable deals. Ask which provisions apply to the actual category and what evidence the lender needs.
The SBA acquisition guide covers wider conditions. A seller schedule organizes evidence without automatically satisfying independent diligence or repayment review. Give the lender the actual model and proposed role changes before treating the seller's adjusted total as accepted underwriting earnings.
Ask which adjustments were accepted or rejected and why. Link earnings with post-close duties and cash needs. Preserve scope. Accepting one item does not approve price or the whole deal. Record remaining review so an adjustment finding is not presented as a financing commitment.
How should a defensible schedule be completed?
- Define the earnings measure, period, and buyer operating model.
- Reconcile every proposed adjustment to recorded expense or income.
- Document purpose, recurrence, disappearance, and required replacement.
- Add necessary downward adjustments and keep disputed amounts visible.
- Separate earnings normalization from capital, debt, and closing cash uses.
- Obtain the relevant buyer, accountant, and lender review.