There is no situation where the buyer doesn’t question if he or she is making the right decision in buying a business. The truth is, every business has its share of both advantages and disadvantages. Regardless of, if the seller had disclosed everything to you is why you perform due diligence.

You want to examine a business to find out what are the problems of the business as well as what is driving its value. You also need to discover what the seller has done over the last few years to dress-up the business in order to maximize earnings:

• Frozen expenditures on capital equipment;

• Cut back on marketing research;

• Withheld introduction of new products.

Normalizing earnings can provide insight into a company’s history and future. Performing this step is key in valuing a business, but it’s also difficult work that involves more than merely reading the company’s financial statements. Normalizing earnings require detailed analysis as well as an understanding of the company’s current and future operations. Once you have that knowledge at your disposal, however, you can begin to see the true picture.

Adjustments to normalize earnings typically fall into three categories, economic, discretionary and nonrecurring.

Economic adjustments relate to items affected by a company’s accounting methods. For instance, the most common economic adjustment is for the basis of accounting. Many small businesses use the income tax basis. In addition to accelerating expenses such as depreciation, it also can ignore expenses (such as vacation pay and bad debts) or defer revenue (such as completed contracts.)