Preparing Business Financials For Sale or Acquisition: Expert Tips from Accountants

By: Jeff Heybruck

When selling a business, it’s important to remember that savvy buyers will scrutinize every aspect.

People, processes, procedures, industry niche, goodwill, website traffic, name recognition and business age are all fair game for evaluation. The buyer will want to know if the owner can be easily replaced, what percentage of total revenue is recurring vs. one-off – we could go on.

And, of course, the business financials will (and should) go under the microscope. As accountants, we’ll focus our advice on getting the books in order and business financials looking great before a buyer does their own financial due diligence. When it comes to preparing the business financials to maximize valuation and increase chances of a successful sale, our CFOs recommend these tips.

1. Clean Up The Financials – We realize this could appear self-serving, but we promise this step isn’t just a hard sell for our own CFO and accounting services. It’s customary (and wise) to engage a professional to conduct “pre-diligence” to help prepare the books for sale. This step helps to ensure financial statements are accurate and consistent. We compare this to getting a house inspected before selling. Clean up the yard and get all the junk out of the house. Here are a few key places to clean up and organize accounting records before selling the business.

   If there is supporting documentation, it needs to tie back to the financial statements; P&L statements and tax returns should match, for example. We’ve seen businesses with a CRM or other sales software that don’t match up – without good reason.

   Any savvy buyer is going to ask for more than the numbers on a tax return, they are going to ask for tax transcripts provided by the IRS. They’re not going to trust that the numbers on the tax return is what was actually filed. If the financials don’t match the tax return, there should be a good explanation. And there could be a good one. It could be as simple as the bookkeeper on staff not adjusting the journal entries that the accountant or CPA gave at year end (in our experience, this happens quite a bit). While this wouldn’t be obvious to an outside party looking in, proper documentation can alleviate any red flags the inconsistency brings up.

   Also, don’t focus only on cleaning up the P&L. The balance sheet is important too. Review the balance sheet for accuracy including days to pay, vendor relationships, quality of assets being transferred and debt.

   Doing job costing? As part of job costing, ensure that everything is allocated to jobs so that the revenue and cost of goods sold is available by customer. Be able to tie the profit to each customer and the sum of all the profit by customer or project totals to the total; this will go a long way in helping the buyer to feel confident that margins can be relied on for accurate forecasting.

2. Maximize Gross Profit – Gross profit is the number one driver of profitability and cash flow. Expect the buyer to take a critical look here. Justify every dollar spent and get margins as high as possible.

   We recommend a “3% Solution.” Here’s what we mean by that: Try to keep COGs flat while increasing revenue by 3%. Remember, little changes can have a big impact on revenue. It’s possible to increase revenue without signing on new customers. Simply following through on estimates and quotes or upselling to existing customers can help. Is there scope creep on certain projects that hasn’t been billed for? Taking the extra effort to coach account managers to bill for changes to scope is a no-brainer.

   Then look for ways to reduce overhead by 3%. Stop paying for anything that isn’t adding real value to the business. Are all of those storage units and Sirius XM subscriptions really needed? If not, they are low-hanging fruit to cut.

   Increasing revenue by 3%, reducing overhead by 3% and keeping COGs the same will have a huge impact to the bottom line. If a business will be sold for a 2 to 3X multiple, that’s a $350k-500k sales price vs. $200-300k.

3. Stay In Your Lane – What products or services grew annual revenue to where it is today? Don’t get fooled into rolling the dice or looking to make that grand slam to win the world series right before selling a business. When we say “stay in your lane” we mean sticking to selling the traditional services and products known to be most profitable in the years before a sale. Too many businesses tend to gamble or want to get the big score knowing that they’ve got two or three times the multiple coming in the year they’re going to sell.

   Here’s why we recommend against this. Let’s say something backfires or the success of a new division or line takes longer than predicted; it’s now sucking up cash. It’s actually going to hurt the business and there won’t be time to get it turned around, especially if a sale is on the short term horizon.

   Additionally, look for “in your lane” opportunities that might be hiding in plain sight. Similar to our advice above regarding easy ways to increase revenue by 3%: are there aging estimates that can be followed up on, or upsell opportunities on existing projects? Finding ways to expand here can add revenue without as much risk.

What makes a good business for tax purposes makes a bad business for selling purposes

4. Pay a LOT of Taxes The Last Few Years Before Selling – What makes a good business for tax purposes makes a bad business for selling purposes. Paying more tax in the years before selling means the business was the most profitable and had the least expenses, making it more attractive to buyers. Minimize any questionable expenses (e.g. a son or daughter on payroll not contributing to the business) or “owner” expenses.

   “Paying more tax” is a hard sell to most business owners. We advise them to remember that they’ll get it all back and then some in the end. Every dollar paid for tax will come back in two, three, four multiples during the sale.

5. Minimize Addbacks – Unusual, non-recurring or discretionary expenses that would not continue under new ownership should be added back to the company’s financial statements under net income. This ensures the buyer is getting a more accurate picture of the company’s profitability and increases the valuation of the business.

   This figure is sometimes referred to as “adjusted” or “normalized” EBITDA. Sales price is usually a multiple of EBITDA, so any big fluctuations from adjustments like these can significantly affect the valuation. That’s why it’s so important to go ahead and address addbacks or adjustments in the years prior to a sale.

   Addbacks can also impact the lending situation. If a company has hundreds of thousands of dollars in discretionary earnings but a high percentage of that is addbacks, the lender is going to be uncomfortable. In addition to lenders, too many discretionary or unusual expenses may also signal concerns with business ethics for the actual buyer.

6. Play It Safe – This isn’t the time for risk, new ideas and expansion. Hold steady and look to sell the core established business.

   If an expansion opportunity arises and it’s one that can’t be refused, carve out that piece and don’t include it in the sale. If a new line of business is on a several year horizon, set it up as a separate entity that’s not being sold.

   Buyers are seeking predictability and a brand new service offering or product without much history doesn’t meet this criteria.

Looking to sell your business and need to hire an accountant to help clean up and organize the books? Lucrum can help make the extensive due diligence process that a buyer (and their accountants, lenders and attorneys) will go through a little less painful. Schedule a no-commitment call with one of our professional accountants here.