Financial Positioning
The seller and his accountant should financially position the business. Small businesses are notorious for their poor financial records and may businesses remain unsold, or are sold for far less than their true market value because the buyer could not decipher the financial past or project the financial future from the scant records provided. Many sellers will, of course, consider their sparse records a blessing when the objective is to conceal losses. Even here the buyer may assume losses far in excess of actual, resulting in an even lower offer.
Financial positioning has three primary objectives:
1). To resent the business favorably.
2). To identify changes in the financial structure needed to best position the business for sale.
3). To project future profitability and cash flow.
The pre-requisite to financial positioning are accurate and current financial statements. Buyers will want to see income statements, tax returns, balance sheets and cash flow statements. These statements should cover the prior three to five years and the seller should certainly offer statements covering a longer span when more favorable trend will emerge.
1). The Profit History: The income statement is the most important financial statement from the buyer’s perspective, since the historical profits remain the threshold for determining future profitability. The difficulty in selling many small businesses – or obtaining a reasonable price- is the lack of profits. It is not that these enterprises are operationally unprofitable, but rather that the profits are not reflected in the income statement. Numerous opportunities exist to shield profits, ranging from unreported income, to extraordinary write-offs, accelerated depreciation and other “paper” expenses that can eradicate the profit picture of event the best income producer. The dilemma is that the statements may reflect dismal earnings-or losses, when the seller suddenly decides to sell. With poor financial statements, the seller can only expect a poor price.
Timing the sale is part of preparation. While it is not always possible to plan selling two or three years in advance for purposes of showing favorable profits, it may be possible to defer the sale for at least one fiscal year if stronger profits can be earned that year. At the very least, prepare quarterly statements to reflect maximum profits from the moment the business is placed for sale.
Reconstruct the financial statements to highlight the extraordinary expenses that do distort the true operational profitability. A simple reconstruction may turn paper losses into substantial profits, more consistent with the true operational profitability of the business. Similarly, the seller should be prepared to outline to the buyer the various factors that have diminished profits, particularly when these same factors are not likely to be encountered by the buyer. Remember that a buyer of small businesses rarely has the managerial experience to interpret the actual profitability of a business. They need to focus on the bottom line without any attempt to reconstruct profitability on their own. The reconstructed statements, accompanying the actual financial statements or tax returns, is an essential sales tool.
Small business buyers are interested in profits, but their primary interests are what they can take out of the business. The business may show no profitability, yet its owners may derive substantial incomes and perks from the business. This too should be outlined in a statement reflecting the salaries, fringe benefits, perks, pensions business owned automobiles, travel and the numerous other “personal” items charged off against the business.
Buyers will also be interested in the sales over the immediately preceding few months of operation. Many buyers believe the business is being sold only because of recent problems, reflected in reduced sales. For this reason, the financial package should disclose monthly sales up to the current period, if current quarterly statements are not available.
The final and perhaps the most important item is to anticipate the buyer’s (or the buyer’s accountants) many questions concerning prior profitability of the business. As with the sale of any other item, the buyer is bound to be skeptical and it remains for the seller to “dress up” the business as attractively as possible. On the negative side, the accountant may have to explain discrepancies between the financial statements to tax returns, chronic losses or adverse trends.
For more information, please feel free to contact our office…716-668-6868 for a confidential conversation or e mail us at Broker@BisBrokersUSA.com.