What story does the financial reporting tell? Is it believable?
By Dave Driscoll
What is a prospective buyer looking for when evaluating the financials of a business?
- Consistent/predictable profitability.
- Does the financial reporting accurately “tell the story of the business?”
How the money flows through the system tells the story of what your business does, how it’s done, and the costs/profit data must support your narrative.
Businesses also create cash and owners have the right to use the cash as they see fit – that’s called Seller’s Discretionary Expenditures (SDE).
YOU CAN ONLY SELL WHAT CAN BE PROVED!
We talked to a manufacturer who had an outlet store to sell excess, outdated inventory. Due to the shop’s location and the nature of the business, transactions were mostly cash. During the development phase of a potential listing for sale, we questioned where the revenue from the retail store was reflected in the financial reporting. The seller’s response was “It’s okay, I’ll tell the buyer there’s actually more revenue, wink-wink.” I could just hear a buyer: “Why should I believe you?” And the seller, with no evidence to support the claim, insisting, “Because it’s true!”
We did not accept that listing.
Financials are extremely important to a buyer, and the integrity of those financials will either build buyers’ confidence in the business or put buyers on alert for misrepresentation of facts to serve the seller’s interest.
Aggressive use of company funds for personal use is an owner’s prerogative, but you must realistically evaluate the associated risks. Identifying and documenting the personal use of business funds in the financial reporting and defining those for prospective buyers is extremely important.
Cash transactions & SDE
Owners that have enjoyed the cash benefits of a business for years will not realize the true market value when it comes time to sell. Believe it or not, I have witnessed sellers expecting to be rewarded for the cash transactions they did not report in a business.
This becomes a HUGE obstacle to selling the business because the seller does not want to “give the buyer all the cash” that the seller knows is there but is not reflected in the business valuation and selling price.
Would you consider buying a business with incomplete, unorganized financials?
Buyer AND seller risk: HIGH.
Buyers won’t trust what they see and will hesitate to proceed. This type of smoke and mirrors calls into question whether the prospective buyer can trust anything the seller says.
Sellers risk trying to sell a business that can’t be sold for the price they want, jeopardizing their life beyond business.™
Learn – and consistently USE – QuickBooks or any other simple accounting system.
If you are not inclined or can’t make the time, establish a relationship with a bookkeeping and tax service to help you produce internal financials on a monthly or quarterly basis, as well as year-end tax returns.
Establish the structure of your profit and loss statement to tell the story of the business. Be consistent in reporting expenses in the same categories.
Keep track of discretionary expenses so they can be identified and “added back” to performance measures to determine the true cash flow of the business. Wean yourself away from extreme SDE expenditures or withdrawals because you will need five years of clean historical financials to support your asking price.
As hard as it may be, if you are considering selling your cash-producing business in the next five years, begin to record those cash receipts in your revenue. You will receive your reward in a higher value at sale.
Once again, when viewing your business, place yourself in the buyer’s shoes… and be honest! Don’t expect more from a buyer than you would be willing to pay!
Dave Driscoll is president of Metro Business Advisors, a mergers & acquisitions, valuation and exit/succession planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at [email protected] or
(314) 303-5600. www.MetroBusinessAdvisors.com
As seen in Dave’s monthly column in St. Louis Small Business Monthly.