Add-Backs

Add-backs are proposed earnings adjustments that add expenses back to reported profit when describing earnings on an adjusted basis.

Why add-backs matter to people buying a small business

An expense the seller calls removable may have helped win customers or deliver the work. If the buyer cuts the cost and expects the benefit to continue, the adjusted earnings describe a business that won't exist after the handover.

Proposed adjustments differ in how strongly the records support them. The label on an add-back tells you little. What matters is the evidence behind it, including what the spending did for the business. A seller calling travel or marketing unnecessary doesn't show that it made no difference to sales.

The seller add-backs diligence guide works through these questions without treating a category name as automatic acceptance.

How add-backs are used

An add-back raises the earnings figure by reversing an expense. The buyer needs to know the starting earnings measure, the reason for each adjustment, and the records behind it. The arithmetic alone says nothing about whether the result is useful.

Say the seller adds back a marketing expense because the buyer could stop the activity. The records show what was bought, but not what it did for customer inquiries. The adjustment rests on an untested link between spending and sales. Calling the expense optional doesn't settle it.

Costs can also rise under new ownership. Reviewing spending by vendor can reveal costs that reflect the seller's relationships, such as supplier discounts that may not carry over. An earnings figure that counts only the expenses a buyer might drop, and ignores the ones that might go up, is incomplete.

Common mistakes with add-backs

Treating every proposed adjustment as established earnings skips the work. Keep the seller's explanation separate from what the records show.

Another mistake is assuming that removing the seller removes the seller's work. Someone may still need to keep relationships and run operations. A past discount also doesn't mean the next owner will buy on the same terms. These are questions about future operating costs, not reasons to accept an adjustment.

Related terms

A quality of earnings review examines the financial presentation and proposed adjustments within its scope. Owner dependence explains why a seller's departure can leave work that still needs doing.

Source notes

Guest remarks come from interviews on The SMB Investor podcast and are paraphrased; examples are our own.