Free Advice

The importance of good financial statements

The number one piece of advice I will offer to all small business owners is to have your financial systems in order, understand them and keep abreast of what is going on. As a consultant, I see a lot of companies. As someone whose work includes working on business buy-sell transactions, I get information on a lot of firms.

Quite frankly, often the financial reporting is a mess. The biggest excuse (for not taking action) and the most common complaint from lenders and business buyers are about poor financial records.

Keep this in mind ¾ all business eventually sell. Either as a whole [entity] or in pieces [at liquidation or auction]. The better your financial records, the higher the likelihood someone will buy your business, and pay more for it.

Maybe it’s human nature. We don’t like something so we don’t do it. And most people don’t like accounting. The time it takes, the stepping outside of a comfort zone or the tedious attention to detail. We’d sooner be selling, making or servicing our product.

Let’s look at some situations and then some actual examples. This is part of a two-part article and next month I’ll provide a list of some top do’s and don’ts.

First, two business buyers approaching two different companies. One has detailed financial records going back forever. The buyer receives a spreadsheet with five years of income and expenses along with a five-year average. Everything expense category is broken down the way you want to see it.

For example, the tax expense is itemized by B&O, employment, L&I, etc. The cost-of-goods-sold breakdown relates to the corresponding source of income. There are absolutely no questions about what anything is (there are always questions about why the expenses are at certain levels, but that’s completely different).

The other buyer entered into discussions with a high-end product and service provider. During our first meeting, the owner complained about the lack of time to tend to administrative issues. When he later sat down with the buyer to review financial statements, his first comment was, “These can’t be right.”

It had something to do with an expense item that should have been no more than a few hundred dollars being reported as $46,000. Income was way off (he did track sales regularly) and there was absolutely no comfort level with what they were looking at (from both parties).

Is it any wonder that was the last meeting between the buyer and seller? The buyer went ahead with another deal, even though this company was much more compatible with his background.

A banker called me and asked if I would meet with his client who was in his late-sixties and ready to sell and retire. He commented that he wasn’t sure how well the firm was doing, but they had paid off a lot of debt over the past couple of years.

We all met at the bank, I got an overview of the business and asked for financial statements. That was a problem. Two incompetent bookkeepers had screwed things up so bad that there was nothing to show. It took seven months to straighten things out (and cost a lot of money). The new bookkeeper had to recreate over two years of records. That means enter every transaction, every deposit, check, invoice, etc.

Retirement is on a temporary hold as we try to work through some of the issues and make sure the records are accurate. The expense and delay were all unnecessary. A little more upfront attention to the accounting function would have prevented this.

Contrast that with another company that had a 65-year old owner who wanted to sell. The books are records were thorough. It was easy to match the financial statements to the tax returns. The in-house accountant was available to answer any questions. Not surprising that the owner received an offer with a couple months, from an ideal buyer.

If you ignored my statement about how all businesses eventually sell, remember that most businesses need some type of banking relationship, often including loans. The bank may not scrutinize things for a secured line of credit as a buyer would for an acquisition. But they will review everything, with the old “fine tooth comb” if someone wants to borrow money to buy your firm. Or, if you want money for more general purposes such as growth.

In any case, whether it’s a bank or a buyer, you will need to work on projections. How can you do meaningful projections? (Never do projections for a buyer, but point out the good and bad in what they do.) Base them on history, research and your market knowledge.

© Copyright John Martinka 2003. All rights reserved.