Don’t be too quick to pass off a company in the red as a bad investment. Not all businesses that show a loss are truly cash negative. In fact, unless you’re acquiring a publicly held company, chances are the company’s tax returns will show a loss. For most private and closely held businesses showing a paper loss is merely a tax planning strategy.
In order to understand the true cash flow of the business, and ultimately its value, you must take the time to look beyond the tax returns to the normalized cash flow (or normalized EBITDA). Normalizing is the process of adding back to net income any discretionary items or personal affects that are attributable to the current owners that do not reflect the true operations of the business.