In order to properly determine EBITDA you first have to present your financial statements correctly.
If you are not using an accounting service that specializes in the funeral or cemetery industry then it is highly likely that your financial statements are not presented in a manner that makes ratio analysis meaningful.
For instance: the way non-industry accountants handle cash advances typically has a significant impact on your ratios. Let’s say that your Revenue before cash advances is $1,000,000, your cash advance revenue is $150,000 and your cost of sales is $210,000. The proper way to calculate your cost of sales ratio is to divide $210,000 by your net revenue of $1,000,000. The result is 21% which is too high (it should be between 15% and 18% in most areas). But, most non-industry accountants include cash advance revenue in total revenue and post the corresponding expense to either cost of goods sold or an expense account. This artificially inflates revenue which drives lower cost ratios. $210,000 divded by $1,150,000 yields a cost of sales ratio of 18.26% thus obscuring the fact that your cost of sales ratio is too high. (For an example of an industry accepted chart of accounts click here.) P&l statment
So, step one in “normalizing “your profit and loss statement is to determine your actual ratios. I would estimate that 8 out of 10 of my clients require analysis and reallocation of accounts to bring their financial statements in to conformity with accepted practice where proper comparisons can be made. I strongly recommend this be done by a professional. There are too many nuances for someone who doesn’t have experience. Typically, it takes me as much as 4 hours to complete this process on 3 years of statements. Once this reclassification is done then ratios can be calculated and the deviations from standard industry experience will draw attention to areas that deserve deeper analysis.
The most common places that can be adjusted are cost of labor (including owners compensation) and facilities (specifically rent to owners). But there are others including redirected income like preneed insurance commissions paid directly to owners instead of through the business that you should be alert to. Ultimately, the goal of normalizing or recasting financial statements is to show what the firm would look like if it were owned and operated by someone who emphasized reporting to investors over sheltering income from the IRS.
It is vitally important to remember that you can’t play games during this step and any professional analyst will refuse to do so.
For example: Let’s assume that your actual cost of labor is 42% of Net Revenue. The normal industry experience (including owners, taxes, benefits etc.) is in the range of 35%. You should only restate labor costs to 35% if you are confident that a buyer can achieve that level. Let’s say you are selling to your children, but you plan to stay on in a reduced role at your current salary and benefits it is not legitimate to recast as if you were going to no longer be paid. (I have seen it done).
For your information, the typical major ratios expressed as a percent of net revenue for normal firms are as follows:
Cost of sales: 15% – 18% (this is often a function of geographic location which impacts cremation rate)
Cost of labor: 30%-35% (with all labor related costs (taxes, benefits, etc)
Facilities: 10% -12% (including rent, mtge interest, leasehold improvements, depreciation, etc)
Disclaimer
While I have experience in business valuation, I am not a Certified Business Appraiser. The explanation and comments contained herein are my own.