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.