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Selling A Business

Financials

Financials are the building blocks of a businesses valuation and worth.  The Financials are the collective interpretation of the physical assets of the business and indicators of its financial health. An owner must have a solid understanding of the financials before they can consider themselves prepared to effectively market and sell the business.

Cash Flow
Cash flow is essentially the movement of money into and out of a business; it's the cycle of cash inflows and cash outflows that determine the business' solvency. One way to do a simple cash flow of a small business is to determine the gross annual income or last 12 months total revenue (including special deposits and withdrawals) then deduct the total of the following basic expenditures.

Labor
Utilities
Carting
Marketing
Cost of Goods Sold
Insurance
Supplies
RE Taxes

The difference between the two amounts, Gross revenue and Gross expenditures will give you Net Income.  The process also should give you a picture of how money flows in and out of the business and subsequently give a better understanding of the cash flow or financial health of the business.

Profit and Loss Statements
A Profit and Loss (P & L) or income statement measures a company's sales and expenses over a specified period of time. A business owner should have this prepared in order to show  financial performance and tendencies.  The Profit and Loss Statement can show why the business is profitable or why the business is in the red.  The Profit and Loss Statement is not a snap shot, but a blue print of the financial structure of the business, a flow of weekly, monthly and quarterly expenses and revenues within the last fiscal or annual year.  Many buyers will request to see the Profit and Loss Statements to gage whether the business has healthy inflows and efficient outflows.  A savvy buyer though will not put total faith in a P&L as it is not a certifiable picture of the businesses financial health. A Profit and Loss Statement can be subjective and manipulated to show a more positive picture than there actually is.  Never-the-less it is an essential document for any owner trying to sell a business. FYI, a P&L is also required by the IRS so every business needs one and should have one to show.

Tax Returns
Tax Returns are the legally required accounting of the businesses annual profits/loss and taxes due.  A business owner should have at least one to three years tax returns to show the businesses performance over time, seasons and circumstance.  Tax returns are one way to see how the business is being put officially for review.  FYI,  A business might be profitable, but for technical reasons it might show a loss on its taxes. An owner should have a ready explanation for buyers if that is the case.

Recasting  
One thing that virtually all small business owners do to "dress up" their business before a sale is to recast historical financial statements for the last three to five years, and draw up projected statements that reflect how the business would look with a new owner.

Most small business owners operate a  business in a way that's calculated to minimize taxes. A owner may have given themselves and family members as many perks and benefits as possible, kept their children on the payroll, plowed a lot of profits back into capital improvements, etc. These and other tactics are designed to keep profits (and  taxes) low, perhaps artificially so.

Now, however, when a owner wants to make a company look as profitable as possible. Ideally, a owner would take steps to improve their actual earnings for several years before putting the company on the block. If time does not permit (or in addition to) this step, they can have their accountant adjust their past income statements to reflect what would have happened if they:

  1. Removed owners salary and perks, and those of family members they don't expect to remain with the company

  2. Removed any expenses or income that would not be expected to recur or continue after the sale (for example, income or expenses associated with discontinued products, or gains or losses from the sale of any business assets)

  3. Removed any investment or other non-operating expenses or income

  4. Removed interest payments on any business loans, since you'll be removing such liabilities from the balance sheet.

Furthermore, a businesses accountant can adjust a past balance sheets to:

  1. Remove any assets that will not be sold with the company.

  2. Remove any obsolete or slow-moving inventory. Value the remaining inventory at current replacement cost.

A owners accountant may have some other ideas; for example, a owner may have expensed some costs that could have been capitalized.

The ability to recast financials is one that should be employed when the actual financials are geared towards a financial structure that is more defensive and less profitable on paper than the business actually is.  A owner must know how to utilize this option when they are beginning to market a business for sale and they must do it before they submit any financials that might conflict with the recasted one.

In conclusion, the financial package of Cash Flow, P&L and Tax Returns will give any buyer a good idea of how the business is doing. Recasting Financials is an option that is desirable when businesses finances are top heavy with perks, and must be done in a timely manner to be effective and relevant for potential buyers.  Thus, a business owner should be ready for the review of all financials and be prepared to Re-cast them when necessary to best enable an expedient and hassle free sale of their business.