Every due diligence normalises the target’s earnings. Non-recurring items are removed. Owner costs are adjusted. Accounting policies are harmonised. The result is “normalised EBITDA,” which is presented as the sustainable economic performance of the business.
But normalisation is judgment. And the judgment embedded in the normalisation can transfer as much value between buyer and seller as the purchase price itself.
Consider a business with the following five-year EBITDA history: Rs 60 crore, Rs 85 crore, Rs 45 crore, Rs 90 crore, Rs 110 crore. What is “normal”?
The seller argues Rs 95 crore: the average of the last two years, reflecting the business’s current trajectory. The buyer argues Rs 78 crore: the five-year average, reflecting the full cycle including the downturn. The difference, Rs 17 crore, at a 10x multiple, is Rs 170 crore of purchase price.
The normalisation methodology determines which figure is correct. And the methodology is itself a judgment that must be defended with evidence and reasoning.
Where Normalisation Goes Wrong
Seasonality ignored
A business whose revenue and margins vary significantly by quarter cannot be normalised using a single quarter’s annualised results. A December quarter annualised may overstate annual performance by 30% if December is the seasonal peak. Normalisation must use a full 12-month cycle, adjusted for the seasonal pattern’s stability.
Owner costs adjusted asymmetrically
The seller adds back every owner-related cost (promoter compensation, family members, personal expenses) without adding the market-rate replacement cost. If the promoter draws Rs 3 crore but a professional CEO would cost Rs 1.5 crore, the add-back is Rs 1.5 crore (the excess), not Rs 3 crore (the full amount). The buyer needs a CEO. The normalisation should reflect the cost of the replacement, not the absence of the role.
Run-rate assumptions
A business that launched a new product line in Q3 and projects it to generate Rs 40 crore of annual revenue has a “run-rate” that the seller wants to include in normalised earnings. The buyer should assess: what evidence supports the run-rate? Is the Q3-Q4 trajectory consistent with Rs 40 crore annualised? Is the customer adoption sustainable? Has the competitive response been factored in?
A run-rate is a projection, not a fact. Including it in normalised earnings treats the projection as if it were achieved. The buyer’s normalisation should include only revenue and margin that has been demonstrated over a sufficiently long period to be considered reliable.
Unusual contracts smoothed rather than excluded
A one-time contract that generated Rs 15 crore of revenue in Year 3 is not “normal” revenue. Averaging it over five years (Rs 3 crore per year) treats it as a recurring Rs 3 crore business, which it is not. The correct normalisation is to exclude it entirely and assess the recurring revenue base independently.
The Normalisation Framework
In Northrop Management Private Limited’s due diligence practice, normalisation follows a structured, documented methodology.
Step 1: Define the normalisation period. Typically the trailing 12 months or the last two complete fiscal years, depending on the business’s variability. For cyclical businesses, the normalisation period should span a full cycle (three to five years) to capture both peaks and troughs.
Step 2: Identify and classify adjustments. Each adjustment is classified as: definitively non-recurring (will not happen again under any scenario), probably non-recurring (unlikely to repeat but not impossible), or recurring but variable (fluctuates in amount but occurs regularly). Only the first category is adjusted with full confidence. The second is adjusted with a probability weighting. The third is not adjusted but is flagged as variable.
Step 3: Document the evidence. Every adjustment requires documentary support: the invoice, the contract, the board resolution, the GL entry that supports the classification. An adjustment without evidence is an assertion, not a normalisation.
Step 4: Apply the methodology consistently. If owner compensation is normalised upward (adding back excess above market rate), it should also be normalised for under-market roles (adding the cost of market-rate replacements for positions the owner performs without compensation). If one-off revenue is removed, one-off costs should also be removed. The methodology should not systematically favour one party.
Step 5: Present the range. Normalised EBITDA should be presented as a range, not a single point. The low end reflects conservative normalisation (only definitive adjustments, full-cycle averaging, market-rate owner replacement). The high end reflects optimistic normalisation (including run-rates, shorter averaging periods, full owner-cost add-backs). The negotiation occurs within the range.
Ashish Chaudhary, Founder and Managing Director of Northrop Management Private Limited, frames the normalisation discipline directly: “Normalisation is judgment. The methodology matters more than the number, because the number is only as reliable as the methodology that produced it. A normalisation that is documented, evidence-based, consistently applied and presented as a range is a defensible basis for negotiation. A normalisation that produces a single number without disclosing the judgments behind it is advocacy disguised as analysis.”
Questions for the Boardroom
- What normalisation methodology was used, and what are the key judgments embedded in it?
- For each adjustment, what documentary evidence supports the classification as non-recurring?
- Were owner costs normalised symmetrically (excess removed and replacement costs added), or asymmetrically?
- Were any run-rate projections included in normalised earnings, and if so, what evidence supports the run-rate?
- What is the range of normalised EBITDA under conservative and optimistic methodologies, and where does the proposed purchase price sit within that range?
Closing Implication
Normalisation determines what the buyer pays. A Rs 17 crore difference in normalised EBITDA at a 10x multiple is Rs 170 crore of purchase price. The methodology that produces the normalised figure is therefore one of the most consequential analytical judgments in any transaction, and it should be treated with the same rigour, documentation and governance scrutiny as the valuation itself.
