A:

Metrics that reflect profitability at various stages are generally used to evaluate the relative financial strength of a company. However, when a business is being sold, potential buyers determine its value as an acquired asset rather than simply looking at its net income.

Adjusted net income is an indicator of how much a business would be worth to new owners. While primary revenue can be assumed to remain stable as long as normal operations remain stable, several kinds of expenses and income streams shift when a business changes hands. Adjusted net income accounts for these factors in addition to a company's bottom line.

Determining Adjusted Net Income

The calculation of adjusted net income begins, as its name implies, with net income. Net income is the sum total of all revenue, expenses, debts, taxes, interest and additional income for a given period. Like other accounting measures, it is susceptible to manipulation through such things as aggressive revenue recognition or by hiding expenses. Net income is the most comprehensive metric of profitability for a company's operations. However, under new ownership, those operations might change.

One major change may involve the salaries of the company's current owners and management. Many business owners pay themselves below-market salaries to help the business along in early stages, or they collect the difference in dividends at the end of the fiscal year. If a new owner hires someone to run the business at the market rate, a certain amount of revenue is needed to cover this salary increase.

Potential buyers need to know how much capital they have to work with to cover all the changes they would implement as new owners.

To estimate the value of a company in this context, various expenses are added back in to the net income. In addition to the salaries of owners and management, this includes depreciation and amortization of assets, one-time payments made for events such as lawsuits or equipment purchases, personal business expenses of the current owner and rent if the property is not owned.

Net income accounts for all actual expenses and income generated for a given period, while adjusted net income reflects only those figures that would not change under new ownership.

RELATED FAQS
  1. How do operating income and net income differ?

    Operating income and net income both show the income earned by a company, but they are distinctly different ways of expressing ... Read Answer >>
  2. What is the difference between revenue and income?

    Revenue is the total amount of income generated by the sale of goods or services related to the company's primary operations.  ... Read Answer >>
  3. Is operating profit the same as net income?

    Understand the difference between operating profit and net income, including how each type relates to the other and how both ... Read Answer >>
  4. How do earnings and revenue differ?

    Revenue is the total income earned by a company for selling its goods and services. Earnings are the bottom line on a company's ... Read Answer >>
  5. What is the difference between earnings and income?

    See how earnings and income are different and when they are used in relation to personal finance versus a business' financial ... Read Answer >>
Related Articles
  1. Investing

    Gross, Operating and Net Profit Margins

    A company’s income statement includes the company’s gross, operating and net profits.
  2. Small Business

    Keeping Your Business Investment on Track

    Business owners need to track business value and performance like any other investment.
  3. Investing

    Calculating Net Income

    Otherwise known as the "bottom line", net income is the most commonly used indicator of a company's profitability. Learn more about how it an investor's decision to own or sell a stock.
  4. Investing

    Bank of America's 4 Most Profitable Lines of Business (BAC)

    Discover how each of Bank of America's primary lines of business impact the company's bottom line and learn about the factors that affect each one.
  5. Investing

    How To Analyze Netflix's Income Statements

    Learn how to read Netflix's income statement, calculate net income and interpret EPS to evaluate the company's current financial condition.
  6. Managing Wealth

    5 Reasons Small Business Owners Sell Their Companies

    Selling a business you've built from scratch isn't done lightly. Consider these moments when the opportunity might be right for you.
  7. Personal Finance

    What Does It Take to Be in the 1%, 5%, 10%?

    To count yourself among the nation's top earners, it takes at least six figures? Here's how the numbers break down for each group.
  8. Personal Finance

    What's Your Net Worth Telling You?

    Net worth provides a road map for retirement - learn if you're headed in the right direction.
RELATED TERMS
  1. Income Basket

    An income basket is a category of income or loss according to ...
  2. Business Income

    Business income is a type of earned income, and is classified ...
  3. Income From Operations - IFO

    Income from operations is a company's earnings before interest, ...
  4. Gross Income

    Gross income is the total income from all sources before deductions ...
  5. Net Loss

    The result that occurs when expenses exceed the income or total ...
  6. Factor Income

    Factor income represents the flow of income that is derived from ...
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center