What is a normalisation adjustment in business valuation?

It is a change to reported earnings that restates them as they would be under ordinary, arm's-length running: owners paid market wages, rent to a related landlord at market rent, private costs removed, one-off items taken out. Valuers make normalisation adjustments to estimate what a buyer would earn; lenders make them to estimate what will be left to service debt. Owner pay is often the largest single adjustment in a small business.

How do you work out a market salary for an owner?

Start with what the owner actually does and how many hours it takes, then price each role as a hire: salary surveys, recruiters' quotes, advertised roles and what similar businesses pay. Add the employer's on-costs, such as pension or superannuation contributions and payroll taxes. An owner who covers two jobs may need two replacements. The result is an estimate, so a lender looks for evidence behind it rather than a single round number.

Is owner remuneration normalisation the same as seller's discretionary earnings?

No. Seller's discretionary earnings, a measure used by business brokers, particularly in North America, adds back one owner's entire pay and benefits to show what the business yields to a single owner-operator who does the work. Normalisation instead charges a market wage for that work. The first suits a buyer who will run the business personally; the second shows what a business earns when every role is paid, which is what a lender needs.

Does normalisation apply when the owner is overpaid?

Yes. If an owner's salary is above what the role would cost to fill, the excess is a return on ownership taken through the wage line, and normalisation adds it back to EBITDA. The same applies to family members paid more than their work is worth. A lender then treats the excess as a distribution in the cash flow, because the family may well keep taking it.

// WORKED EXAMPLETHE ARITHMETIC A DECISION RESTS ON

Owner Remuneration Normalisation: a Worked Example

Price the founder's job as if someone else had to do it.

BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED 2026-11-07 · 5 MIN READ

// THE SHORT ANSWER

A lender reading an owner-run business asks what it would earn if the owners' work had to be bought at the going rate. Owners of private companies set their own pay, often for tax reasons, so the wage cost in the accounts can be far below or above what the jobs are worth. Normalising it means repricing each owner's role at what a hired replacement would cost, including employer on-costs, and adjusting EBITDA by the difference. The cash the family takes out does not change. What changes is the earnings the business keeps once an owner stops working for less, or more, than the job is worth.

BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.

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// 01 — WHY THE WAGE LINE MISLEADS A LENDER

In a business run by its owners, the line between wages and profit is drawn by the owners. In the UK, director-shareholders of small companies commonly take a modest salary and the rest as dividends, which are paid out of profit and do not appear as a cost. In Australia, owners may be paid through dividends or trust distributions, neither of which is an expense of the business. In New Zealand, a shareholder-employee's salary is often allocated for the year, paid without tax deducted, at a level chosen with the year's result and the family's tax in mind. And in all three markets a sole trader cannot employ themselves, so the accounts carry no cost for the owner's work at all, which is the ground the owner drawings page covers.

None of this is wrong. It means only that EBITDA in an owner-run business measures what the owners chose to leave in it. A lender wants what the business earns after paying for every job it needs done, because a market wage becomes payable the day an owner retires, sells, falls ill or simply decides to pay herself properly.

// 02 — HOW THE ADJUSTMENT IS BUILT

For each owner or family member on the payroll:

Adjustment = what the business pays − what the role would cost to fill

Normalised EBITDA = reported EBITDA + the sum of the adjustments

(paid below market: the adjustment is negative; above market: positive)

The work is in the second term. A lender first lists what each owner actually does, because a founder who runs the clinic floor and the business may be two hires, not one. It then prices each role from salary surveys, recruiters' quotes, advertised vacancies or what comparable businesses pay their managers, and adds the employer's on-costs: pension, superannuation or KiwiSaver contributions, payroll taxes and, in the UK, employer's National Insurance. Family members paid for little work come out, and a spouse working unpaid goes in. Private spending run through the business, such as a car or a holiday, is a separate adjustment and is kept separate so neither is counted twice.

// 03 — THE EXAMPLE

A group of three physiotherapy clinics, constructed for this page like every figure in it, asks its bank for a US$1.2m loan to fit out a fourth. Its founder is the clinical director and runs the business; she pays herself a salary of US$60,000 and takes dividends of US$150,000. Her husband keeps the books part-time for US$70,000. The bank estimates the founder's role would cost US$165,000 to fill, on-costs included, and the bookkeeping US$30,000. Figures are in US$ thousands.

Reported EBITDA 540

Founder: paid 60, role costs 165 −105

Husband: paid 70, work costs 30 + 40

Normalised EBITDA 475

Debt after the new loan: 400 + 1,200 = 1,600

Leverage, reported: 1,600 ÷ 540 = 2.96×

Leverage, normalised: 1,600 ÷ 475 = 3.37×

Cash after the family is paid, reported: 540 − 150 = 390

Cash after the family is paid, normalised: 475 − 45 − 40 = 390

Counted twice: 475 − 150 = 325

The business carries 3.37 times, not 2.96, once both jobs are priced at what they cost. The cash left this year is US$390,000 either way: normalising moves money between the wage line and the dividend line, it does not create or destroy any. The founder's dividends are now read as US$105,000 of wages she was not charging plus a US$45,000 return to her as owner, and the husband's extra US$40,000 is a distribution too. The last line is the mistake: taking the full dividend off normalised EBITDA deducts the founder's missing wage twice. The figures are the example's, not a market norm.

// 04 — HOW IT DIFFERS FROM OWNER DRAWINGS

Normalisation corrects the cost of the owners' work inside the earnings. Owner drawings are the cash the owners take out, read below the earnings to find what is left for the bank. On a company the two meet in the dividend line; on a sole trader they meet in the drawings account. A desk can apply both, provided each dollar is assigned once: the part of what an owner takes that pays for the job, and the part that is a return on owning the business.

DEFINED IN ONE PARAGRAPH → · OWNER DRAWINGS → · GLOBAL CASH FLOW →

// 05 — WHERE IT DECIDES A FILE

It decides any loan that funds a change of owner. A buyer who will not do the founder's job must hire someone to do it, and a manager who buys the business will want to be paid a full wage; either way the reported EBITDA overstates what services the acquisition debt, which is why a management buy-out is read on normalised figures. It also decides the covenant. A covenant set on reported EBITDA of US$540,000 tightens on the day the founder starts paying herself a market salary, with nothing else in the clinics changed, so a lender sets its levels with the normalised figure in view and reads key-person risk beside it.

ADJUSTED EBITDA → · SHAREHOLDER CURRENT ACCOUNT →

// SOURCES

The documents the statements on this page rest on. Each was opened and checked when cited.

Inland Revenue (New Zealand), Transferring tax credits to shareholder-employees — Describes a company allocating a shareholder-employee salary for the year, paid without tax deducted — the New Zealand arrangement in section 01.

// QUESTIONS PEOPLE ASK

What is a normalisation adjustment in business valuation?: It is a change to reported earnings that restates them as they would be under ordinary, arm's-length running: owners paid market wages, rent to a related landlord at market rent, private costs removed, one-off items taken out. Valuers make normalisation adjustments to estimate what a buyer would earn; lenders make them to estimate what will be left to service debt. Owner pay is often the largest single adjustment in a small business.
How do you work out a market salary for an owner?: Start with what the owner actually does and how many hours it takes, then price each role as a hire: salary surveys, recruiters' quotes, advertised roles and what similar businesses pay. Add the employer's on-costs, such as pension or superannuation contributions and payroll taxes. An owner who covers two jobs may need two replacements. The result is an estimate, so a lender looks for evidence behind it rather than a single round number.
Is owner remuneration normalisation the same as seller's discretionary earnings?: No. Seller's discretionary earnings, a measure used by business brokers, particularly in North America, adds back one owner's entire pay and benefits to show what the business yields to a single owner-operator who does the work. Normalisation instead charges a market wage for that work. The first suits a buyer who will run the business personally; the second shows what a business earns when every role is paid, which is what a lender needs.
Does normalisation apply when the owner is overpaid?: Yes. If an owner's salary is above what the role would cost to fill, the excess is a return on ownership taken through the wage line, and normalisation adds it back to EBITDA. The same applies to family members paid more than their work is worth. A lender then treats the excess as a distribution in the cash flow, because the family may well keep taking it.

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THE READING ROOMIN ONE PARAGRAPHOwner remuneration normalisation What is owner remuneration normalisation, and why does it change a small firm's EBITDA?