"Normalized income" represents the net income a business generates without regard to special treatment of certain expenses and acquisitions. When a company is up for sale, potential investors want to know what the business is capable of earning, without regard to expenses paid to parties related to business owners, inflated owner salaries or non-recurring costs. Analysts typically want to see normalized income data averaged over several years to gain a realistic snapshot of true profitability.
1. Obtain current and past financial statements for the business. If available, obtain financial statements for the last five years. For each year, perform normalization steps separately.
2. Look at the net income before taxes. This is shown on the income statement.
3. Calculate non-recurring expenses that would not be paid by another business owner. Examples include salaries paid to non-employee family members, personal expenses that were deducted by the business, and other miscellaneous expenses that are not required to operate the company. Add the total non-recurring expenses to the net income figure.
4. Look at the owner’s salary. Subtract the amount from net income, and add back the salary a regular non-owner would be paid to perform the same job functions.
5. Look at capital expenditures acquired by the business during the year. These debts are shown on the balance sheet as liabilities. If the expenses are non-recurring, or if they would not be incurred by another business owner, add the cost of the expenditures to the net income for the year.
6. Add the sum of your adjusted net income totals for each year you analyze. Divide the total by the number of years in your calculation. The result is the average normalized income.
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