Expensive Mistakes in Business Valuations
- Arnold Shields
- Oct 9, 2012
- 3 min read
Updated: Jun 3
Twice this past week, we've spoken with new clients who lost hundreds of thousands of dollars because they misunderstood the fundamentals of how a business is valued. These weren’t exotic mistakes, they were painfully common.
Here’s what went wrong and how you can avoid making the same errors.
1. Capitalising the Owner’s Salary
This is the most common trap we see.
When valuing a business, the future maintainable earnings must be calculated after deducting a fair commercial salary for the owner. That’s because the value of the business assumes the buyer can hire someone to manage it. If you don’t deduct a commercial salary, you’re not buying a business—you’re buying yourself a job.
In one case, a small business was being valued for a family law matter. The accountant took the owner's low earnings and multiplied them by three, without accounting for a commercial wage. The resulting business valuation was grossly overstated. In reality, the business had no goodwill. If a business can’t pay the owner a market-rate salary, it’s not generating profit beyond wages—therefore, it has no real transferable value.
2. Adding Back Depreciation Like It's Free Money
Depreciation is not just an accounting formality—it's a real cost spread over time.
Many business brokers add back depreciation to boost reported earnings, arguing it's a “non-cash” item. That logic is deeply flawed. Every business will eventually need to replace assets—whether that’s computers, vehicles, or equipment. By ignoring depreciation, you're pretending the business can run forever without reinvesting in its tools of trade.
Depreciation represents future capital outflows. If you add it back, you're artificially inflating the business’s earning capacity and misleading the buyer.
3. Accepting Undeclared 'Cash Earnings' as Real Value
This one is both common and dangerous.
We often see sellers claim their business makes more money than declared in their tax returns due to “cash takings.” But black market cash is unverifiable. It’s not reported. There’s no documentation.
Worse still, many businesses that under-report cash income also under-report cash expenses—like paying staff or suppliers under the table.
So even if some cash earnings exist, there’s usually no net benefit because the real costs aren’t on the books either. Any valuation based on handshake agreements or undocumented earnings is unreliable and risky.
Want to Understand Business Valuation the Right Way?
If you're buying, selling, or valuing a business—especially during a family law proceeding, don’t rely on guesswork or industry gossip. Head over to the Lawyers Zone on the Dolman Bateman website where we break down the key valuation principles and real-world examples through helpful videos.
A little education now could save you hundreds of thousands later.
If you want to find out more about business valuations in the principles involved go to our Lawyers Zone section of Dolman Bateman where we have a number of videos on the valuation of of businesses and the common mistakes people make.
Disclaimer:
The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.
