Maintainable Earnings

A print shop reports $2.4 million profit, including a $500,000 one-time gain and a $300,000 unusual legal expense, so simple arithmetic suggests $2.2 million after removing both ($2.4 million - $500,000 + $300,000). A buyer still needs to ask whether major customers and margins will continue.

RICS's international business valuation glossary defines normalised earnings and normalising adjustments for nonrecurring or unusual items, and a quality-of-earnings discussion by the McLean Group distinguishes that arithmetic from a deeper review of revenue sustainability, accounting policy and working capital. Name the earnings measure, since net profit, operating profit and EBITDA have different cost treatment and multiples should not be compared against inconsistent bases.

Start with reliable statements by reconciling reported accounts, management adjustments and tax records, because an unverified spreadsheet is a weak starting point, and review several years so that one unusually strong or weak year does not stand in for a normal period. Identify genuinely one-time items carefully, as a flood repair or asset-sale gain may be unusual, but repeated 'one-off' restructuring costs could be part of normal operations.

Remove one-time gains such as a property sale or insurance settlement, which can inflate a year's earnings without improving recurring trading profit, and add back unusual costs only if they would not be needed for future operations, with invoices and context required. Normalise owner pay, because a privately owned company may pay its owner above or below a market cost for the actual role and should replace it with a supportable future management cost, and check related-party terms, since below-market rent or unpaid family work can make profits appear high.

Examine customer concentration and the order pipeline, because a large contract expiring soon may make historical earnings unsustainable and signed recurring contracts differ from speculative forecasts. Check price and volume, as a temporary price spike or stock shortage can lift profit, and review supplier costs, since a future wage, rent or material increase can reduce expected profit and historical cost is not always maintainable.

Consider working capital, because aggressive revenue recognition or delayed supplier payments can flatter earnings while cash quality weakens, and separate nonoperating assets so that interest or rent from an asset not included in the business being valued is treated consistently with the valuation scope. Check depreciation and capex too, since EBITDA excludes depreciation but a capital-heavy business still needs replacement spending, so a high EBITDA is not free cash flow.

Assess key-person risk, because if the owner drives sales and will leave, replacing that relationship or skill may cost more than a salary adjustment, and distinguish pro forma improvements, since a planned cost saving is not maintainable earnings today unless implementation and sustainability are supported. Avoid seller-only add-backs by challenging each adjustment with documents and ensuring the same item is not added back twice, and choose a future period carefully because a business that has just opened a new site makes last year's profit a poor baseline.

Use valuation carefully, since a multiple applied to maintainable earnings is one method, not a price guarantee, and growth, risk, debt and market conditions affect value. Present a range, as uncertain contracts and costs can justify scenarios rather than one falsely precise number, and document the bridge showing reported earnings, each adjustment, source and final estimate so reviewers can understand disagreement.

Look at taxes separately, because taxable income adjustments are not identical to valuation normalisation, and use independent review for major deals, since a quality-of-earnings analysis can test policies, customers and cash conversion beyond a simple add-back list. For owners, maintainable earnings are a defensible estimate of continuing earning power, and the value lies in evidence for what persists and what will change.