L-123 · Lesson
Work backward from the income you need
Free Practitioner review pending Reviewed 2026-10-03
The decision
What must a business earn to pay my household and my loan, before I count the costs a listing leaves out?
Why this matters
Most buyers read a listing from the top: here is what the business earns, so can I live on that? It sounds sensible, and it lets the listing set the terms. A business that earns a decent amount looks like an answer to a question you have not yet asked.
Working backward reverses the order. You start from your household: how much income do you need? You add what the loan will take each year, and you list the costs the listing does not show. That total is the bar a business must clear. Any business below it is out, however pleasant the owner or well kept the trucks.
The point of the bar is not precision. It is that you decide what "enough" means before you meet a business that might tempt you to lower it. This lesson finishes your Acquisition Capacity Model and with it Stage 2. The Deal Lab picks up your work from here.
Concept: the bar a business must clear
Four parts
- Income you need, before tax
- plus loan payments each year
- plus costs the listing leaves out
- equals the earnings a business must produce
The capacity tool computes the first two and leaves the third as "unknown", for a reason you saw in the last lessons: you cannot yet know the costs of a business you have not seen. So the tool's number is a floor. It is the least a business must earn, and every cost you add later raises it.
Your income need, before tax
The income you need comes from your Buyer Profile, and it is before tax. Tax depends on how a deal is structured and on your own circumstances, and no lesson here knows either. That is a question for your accountant. Include in your income need what you will have to pay for yourself that an employer would normally cover, such as health insurance, because those costs do not appear anywhere else.
This lesson does not analyze what is left for you after tax and after the business's own needs. That analysis comes in the Deal Lab as buyer cash. For now, the point is to state the need and carry it forward.
Loan payments are set by three entries
The tool works out the yearly cost of the loan from three things: the amount, the interest rate and the term. It holds the rate you enter constant and assumes level monthly payments that repay the loan fully. A real variable rate can reset, and the payment with it. Each entry is a lever.
- Amount comes from the price, the costs and your cash, which you worked on in the last two lessons.
- Rate is labeled "School illustrative financing default" until a lender tells you otherwise. A small change moves the payments, and so the bar.
- Term is how many years the payments run. A shorter term raises the yearly payment, and a longer one lowers it.
The term is not a free choice. Programs and lenders set limits.
This is one program and one rule as of one date, and it is the rule for buying a business, not for every use of a 7(a) loan. Other lenders and loan types differ, and your lender confirms which structure is permitted. The point to take away is that a long term is not something you pick to make the payments look small. Treat the term as a number you confirm.
Costs the listing leaves out
The bar grows when you add the costs that a listing's earnings usually do not carry.
- Replacement labor. If you will not do an owner job, someone must, and the business pays for them. This is the manager cost from the Buyer Profile lesson.
- Equipment. Trucks and machines wear out, and replacing them is a cost the earnings may not reflect.
- Working capital. If the business grows or customers pay slowly, it needs more cash tied up.
- Your own benefits and costs, which belong in your income need.
The tool shows replacement labor and equipment as "unknown" so that you cannot forget them. You can add your own figures as you learn them. A manager quote from your market, for example, turns a floor into a more realistic bar.
What "earnings" means here
The word is used loosely in listings, and Stage 3 teaches how to test it. In this lesson it means the profit a business produces for its owner before the owner is paid for the work and before loan payments. That is the number a seller reports, and the number you test later. For now, your job is to know your own side of the comparison.
How your Stage 2 work carries forward
Your three outputs so far are not separate exercises. The Deal Lab uses them as the standard a listing is held against.
| Your output | What it holds | How the Deal Lab uses it |
|---|---|---|
| Buyer Profile | Your role and income need | The income a business must leave for you, once you do the owner's jobs or pay someone to |
| Buy Box | Business type, price range, distance, must-haves and exclusions | The Initial screen compares a listing's type, price and distance with your box and flags a conflict. You carry the must-haves and exclusions into the scorecard yourself |
| Capacity Model | Your cash, your reserve, the loan terms and the bar | The Deal Lab asks the same questions about a specific listing: what it would cost, what loan it would carry and what is left for you. Financing, buyer maximum, buyer cash and the Decision Record each return to them |
Nothing in this table scores you or recommends a deal. It says where each piece of your work will be used, so that a number you wrote in Stage 2 is the one you hold against a listing in Stage 3.
Worked example: raising the bar
Illustrative example
This buyer is fictional and the numbers are invented for this lesson.
Jun needs $97,000 a year before tax. A deal would carry a loan of $414,800. Jun enters an illustrative rate of 9.25% over 10 years, his own entry and not a lender's quote, and the yearly loan payments come to about $63,730.
| Owner-operator | Manager-run | |
|---|---|---|
| Income Jun needs | $97,000 | $97,000 |
| Loan payments a year | $63,730 | $63,730 |
| Replacement labor | none | $62,000, from a manager quote |
| Earnings the business must produce, at least | $160,730 | $222,730 |
The tool would show the first column, with replacement labor "unknown". The second column appears once Jun has a quote.
Now change one entry. If the rate is 11% and not 9.25%, the yearly payments are about $68,566, and the owner-operator bar becomes $165,566. The one change adds $4,836 a year to what the business must earn.
None of this says what the business is worth or whether Jun should buy it. It says what the business must clear to pay Jun and the lender, before equipment, working capital or any other cost is counted.
The bar changes how Jun hears a listing. An earnings figure no longer sounds good or bad on its own. He knows what it must be compared with.
Failure modes
1. Starting from the listing's earnings and working forward
How it shows up: the buyer sees an earnings figure that looks respectable and then builds a case for why it is enough. What to do: write the bar before opening the listing, and let the listing prove it clears the bar.
2. Forgetting the loan in the household's math
How it shows up: the buyer compares the business's earnings with household income and treats the difference as free money. Loan payments take their share first. What to do: always subtract the yearly payments before saying anything is left for you.
3. Leaving out what the listing leaves out
How it shows up: the bar is based on income plus the loan, and replacement labor, equipment and working capital are treated as small. What to do: carry each as a named line, "unknown" if you must, until you have a figure.
4. Hoping growth closes the gap
How it shows up: a business that falls short of the bar is described as one that "has room to grow". The bar is then met by a forecast, not by earnings. What to do: measure a business against the bar as it is. Growth is something you may earn later and the loan is due now.
Buyer rules
Buyer rule
Set the bar before you meet the business. Let the listing prove it clears it.
Buyer rule
The number you compute is a floor. Every cost you add later raises it.
Apply it
- Confirm your income need from your Buyer Profile and add what you will pay for yourself that an employer would normally cover.
- Write down which terms are placeholders and what you will ask a lender to replace them.
- Collect the replacement-labor quote for the role you would hire, if you will not do it yourself.
- List the equipment a business in your chosen trade would need to replace, and ask an owner how long it lasts.
- Change one term at a time and note how much the bar moves. You are looking for the term that matters most.
- Write your bar in one sentence: "A business must earn at least this much before it leaves me anything."
Tool: the Acquisition Capacity tool
You are finishing the capacity model, and the part to look at is the section called Earnings a business must produce. It shows your income, the loan payments and two unknowns, then the minimum total.
Nothing new has to be entered. Replace the loan terms with what a lender has told you, if you have it. If not, leave the school defaults and say so aloud when you share the result with anyone. Then change one term at a time and watch the minimum. If the rate or the term moves it a lot, that is where your conversation with a lender should start.
Read the line "at least" literally, and add the unknowns yourself on paper: the replacement labor you priced and the equipment you listed. The tool saves your model when it has valid cash, reserve and terms, and when your Buyer Profile holds an income need and your Buy Box a highest price. Before you move on, look at three things: whether the cash side and the earnings side agree with your Buy Box ceiling, whether any entry is a default you have not replaced, and whether you could explain every number to a lender. The model is a planning model and not a lender's: it tells you what range is worth investigating. Then take your saved outputs to the Initial screen, where a real listing meets them.
Lesson, then tool, then output
Acquisition Capacity
You finish this lesson by producing a real output: Acquisition Capacity Model. Progress in this school is work you have completed, not pages you have read.
Next decision: Reading a listing: what it says and what it leaves out
Evidence required
The bar rests on four inputs, and each has someone who can check it.
Your household can check the income need. A partner who has seen the monthly budget is the best test of whether the number is real.
A lender can check the terms. Until you have spoken to one, the rate and term are placeholders, and your results should say so.
An accountant can check how tax and benefits affect the income you need, and what is the right way to count your own costs.
Owners in your trade can check the costs the listing leaves out. Ask what they pay for a manager, how long their equipment lasts and what surprised them.
A bar you can defend to all four is a bar worth carrying into a deal.
Decision question: is it enough?
A listing shows earnings of $190,000. The buyer needs $97,000 before tax, and the yearly loan payments would be $64,000. What can the buyer conclude?
Open each answer to see why it is or is not the stronger one.
Yes, provided the business is growing
Weaker answer. Growth is a forecast, and the loan payments are due now.
The seller's figure clears the minimum of $161,000, and whether it is enough depends on testing the earnings and on the costs not yet counted
Defensible answer. The bar is a floor. The listing's figure is a claim, and the unknown costs have to fit inside the headroom.
Yes, it is enough, because $190,000 is well above the $97,000 needed
Weaker answer. This ignores the loan payments, which take their share first.
No, since the loan payments take most of the earnings
Weaker answer. The payments are part of the bar, not a reason to reject. The business clears it on the seller's figure.
Scenario check
A buyer wants to know how much tax will come out of the $97,000 income need. What should happen?
Open each answer to see why it is or is not the stronger one.
The buyer ignores tax until after closing
Weaker answer. Tax affects what the household keeps and should be understood before a decision.
The buyer asks an accountant, since tax depends on how the deal is structured and on the buyer's own situation
Defensible answer. The tool deliberately works before tax. The right answer needs a professional and the actual deal structure.
The buyer subtracts a standard tax rate and uses the result
Weaker answer. No single rate is correct for every household and every deal structure.
A buyer's lender raises the interest rate by a point and a half. What happens to the earnings the business must produce?
Open each answer to see why it is or is not the stronger one.
Nothing, since the income need stays the same
Weaker answer. The income need is one part of the bar. The loan payments are another.
They fall, since a higher rate means more profit for the business
Weaker answer. A higher rate costs the borrower more and does not make the business earn more.
They rise, because the loan payments rise, so a business that cleared the bar before may no longer clear it
Defensible answer. The bar includes the loan payments, so any change in the terms moves it.
A buyer sets a 25-year loan term to make the payments look smaller. What should the buyer do first?
Open each answer to see why it is or is not the stronger one.
Shorten it to the shortest possible to be safe
Weaker answer. A very short term raises the yearly payments and the bar. It may help in other ways and is not a safe default.
Ask the lender what term is available for this kind of purchase, since the term is a limit to confirm and not a free choice
Defensible answer. Programs and lenders cap the term, especially for the goodwill part of a purchase.
Keep it, since a longer term always helps the buyer
Weaker answer. A longer term lowers the yearly payments and may simply not be available.