What is a Recast?
The sole purpose of a recast is to adjust the business’s tax returns so that it better reflects the actual cash flow (income) provided to the owner.
A condition of a sale is that the seller must prove the owners’ cash flow or net income which was represented in the listing or internet ad.
Some sellers are not comfortable about showing their tax returns. However remember – the tax return is supposed to show how much money the business made. A seller cannot withhold their tax return and simply tell a buyer – my business makes a lot of money – trust me! That’s not acceptable – a buyer will look for another business with good financial records. A simple recast clearly shows a buyer how much money he will earn if he buys the business.
What creates a problem is that most business owners diligently minimize their tax liability by maximizing their expenses. That is why a tax return does not reflect the true earnings of a business – because it’s top loaded with personal expenses that are not related to the actual business operation. Therefore it is necessary to adjust the reported tax return with a recast to reflect the actual cash flow to the owner. The only time a recast would not be necessary, is if an owner doesn’t run any personal expenses through the business, which only happens in about 30% of the time.
In recasting we “add back” expenses considered discretionary, non-recurring , non-cash or extraordinary. Discretionary means not necessary to support the revenue of the business (personal expenses) and would not flow to the new owner. Extraordinary means excessive above normal levels, non-recurring means a onetime expense, and non-cash is usually tied to both depreciation and interest expense.
Although recasting is a standard practice in business valuation, it can take a buyer and seller a while to adjust to the concept. Sellers need to understand that these are valuations, not tax-deriving documents. Without recasting, an owner (seller) would understate the cash flow (owner benefit, OB) of the business and would create an asking price that is too low!
To sell your business, a detailed financial recast must be prepared as a joint venture between seller and broker .