Explain the difficulties of estimating cash flow for private firms and the adjustments needed to arrive at normalised earnings
The idea
Cash flow estimation for private companies needs care. Normalised earnings should reflect the ongoing benefit to a buyer: adjust owners' compensation to market rates, remove non-recurring items and discretionary expenses such as personal costs run through the business, restate related-party transactions such as rent paid to an owner at off-market rates, and value non-operating assets such as surplus property separately. A strategic buyer may add synergies that a financial buyer would not. Management forecasts may be optimistic, and the analyst must decide whose perspective the valuation takes: the existing owner, a financial buyer or a strategic buyer. The trap is ignoring excess owner compensation, which understates normalised earnings, or leaving above-market rent in expenses.
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