Everyone who wants to buy a business wants to know how much money did the business really make. This is referred to as normalized income. This means the income that would remain for the new owner once the old owner left. That means that all personal expenses are removed, salaries paid to family who are not working in the business and a reasonable salary for the owner. Many sellers of businesses do not realize that if they work there every day 5 days a week, they need to be paid a salary to cover their work. Anything over and above this reasonable salary is considered earnings attributed to the shareholder.
The current economic conditions can generate temporary surges in earnings. If you have a business which is receiving infrastructure business, the additional revenue will last 1 to 3 years. After that, the revenue and profits from this one time work disappears. Is this part of normalized earnings? If you are a business and has to pay PST for supplies, once HST arrives, you no longer need to pay PST and if you are a HST registrant, you may be eligible to obtain the entire 8% back as a HST input credit. Is your prior years earnings understated because the new owner would not have to pay the PST which you did in prior years? If you are buying goods from Europe, the euro has depreciated and your buying power has gone up significantly. If you have buying goods from the US and are located in Canada, your buying power has also gone up if you are paying in US dollars. These fluctuations are all due to foreign currency fluctuations. Since these have changed so significantly in the last year, are these temporary or are these permanent? If they are temporary, is the currency fluctuation, good or bad, part of normalized earnings?
If you are buying a business, you can no longer just look to see how much profit the business was earning, you now should look at the composition of those earnings to determine if they are permanent or temporary and offer a price for the business accordingly.