Building Business Value, Tip 2

Tip 2: Logical and Understandable Financial Reporting is Essential

by Dave Driscoll

What is a prospective buyer looking for when evaluating the financials of a business?

- Profitability.
- Consistent, predictable profitability.
- Financial reporting that accurately “tells the story of the business.”

How the money flows through the system tells the story of what your business does and how it’s done, and the costs/profit data must support your narrative.
Businesses also create cash, and owners have the right to use that cash as they see fit — this is called Seller’s Discretionary Expenditures (SDE).

YOU CAN ONLY SELL WHAT CAN BE PROVED!

We once talked to a manufacturer who had an outlet store that sold excess, outdated inventory.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 financials. 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 saying, “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 buyers, and the integrity of those financials will either build buyers’ confidence in the business or put buyers on alert for misrepresentation of facts designed 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 financials and defining those for prospective buyers is extremely important.

Cash transactions & SDE
Owners who 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.™

Solutions:
Learn — and consistently USE — QuickBooks or any other simple accounting system.

If you aren’t 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 business brokerage, valuation and exit 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. For more information, visit www.MetroBusinessAdvisors.com.