By Dave Driscoll
No business owner enjoys sending 40% of your hard-earned cash to the government that hasn’t contributed any equity to the business or produced revenue while creating more administrative costs for the business. But the requirement to pay taxes isn’t going away.
Most owners seek legal ways to reduce the impact of their business’ taxes. This is a legitimate strategy…but it is critical to keep track of those expenditures that reduce your taxes. Not being able to identify those “discretionary expenditures” will come back to haunt you later when you want to maximize the proceeds from the sale of your business!
Business valuations are based on historical earnings. If the business shows no earnings, the business is not worth much more than the liquidation value of its assets, so maintaining accurate records to reconstruct the business’ cash flow is critical to maximize the eventual selling price.
To help determine the asking price, business brokers review three to five years of financials with the intent of “normalizing” the cash flow produced by the business. Normalizing is the process of adding back – or increasing – earnings based on the owner’s discretionary expenses. In other words, adding back the owner’s “tax minimization strategies.”
Minimizing your tax bill legally is not a problem. However, you DO need to track all those strategies in a detailed listing of accounts and amounts of discretionary expenditures. This documentation will help your business broker determine accurate cash flow which, in turn, will appropriately price your business.
Businesses that handle cash often debate whether to record cash sales. Not recording the sale gives the owner the immediacy of cash in their pocket without paying tax but it does not record the revenue to offset the expenses of the sale… therefore producing a loss on that sale.
Without a road map of actual sales and discretionary expenses, the business valuation will likely miss critical cash flow to establish an accurate business value. Those omissions could dramatically impact the asking price for the business.
Some companies report the financial operating results on an internal book basis reflecting the results of normal operations and noting “owner’s discretionary expenses” below operating income. This produces a true picture of the cash flow created by the business before tax minimization strategies. At tax time, the accountant adjusts the internal book reports to tax reporting that reflects all the legitimate adjustments to income to calculate the business’ tax liability.
Business value is primarily about earnings, and potential buyers expect historical evidence of those earnings. Without the ability to demonstrate the actual discretionary cash flow produced by the business, supporting an appropriate asking price is very difficult.
My advice is to document your discretionary/tax minimization strategies reflected in your operating statements for at least three years prior to beginning the process of selling your business. Without those records, you won’t be able to prove your historical earnings and the value of your business will suffer when you are expecting a reflection of your years of hard work. You can only sell the cash flow you can prove.
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 DDriscoll@MetroBusinessAdvisors.com or (314) 303-5600. www.MetroBusinessAdvisors.com
As seen in Dave’s monthly Small Business Monthly column.