Succession Planning. How sound are your financial statements?

Finances, Succession Planning

How to be Sure Your Financial Statements Will Help You Sell Your Business

November 11, 2016

Succession Planning Question 5: How sound are your financial statements?

Whether you plan to sell your business to family members, employees or someone else, it’s essential that your financial statements show a true and accurate picture of your company’s fiscal health. Poorly formatted or inaccurate financial statements won’t give you a realistic idea of what your business is worth, will raise questions with any savvy buyer and, most likely, reduce the amount a buyer is willing to pay.

Another problem with poor financial accounting is the opportunity for fraud. Many a company has gone out of business thanks to employees who embezzle money and are able to cover their tracks because of poor financial controls.

So what can you do to insure that your financial reporting is accurate and you are less vulnerable to fraud?

  • Understand your financial reports. If accounting, or comprehending income statements and balance sheets are not part of your skill set, it would be worthwhile to learn. If you use an outside accounting firm, they can teach you what you need to know. Otherwise, you may need to take a course or two. The goal is to always have a clear picture of your company’s financial condition, and the ability to recognize any red flags.
  • Establish internal controls. When it comes to financial matters, redundancy is a good thing. One person signing checks, issuing purchase orders and making payments to suppliers is a classic recipe for disaster. No matter how well you know and trust good old Fred or Mable, and no matter how long they’ve worked for you (or been a member of the family) it’s never wise to give them sole responsibility and authority over financial matters. It’s also not fair to them, if anything goes wrong.
  • Be consistent. Resist the temptation to change your accounting methods as you prepare to sell the business. This makes it harder for a buyer to compare one year to another and raises questions about whether or not you’re trying to hide or embellish something. If your reporting formats are sound to begin with, stick with them.
  • Consider external oversight. Again, if your strong suit isn’t accounting, it’s a good idea to involve outside professionals. You may wish to work with a credentialed accounting firm to prepare, or at least periodically review your financial statements. It’s also wise to have them perform regular, thorough audits that investigate every transaction. Audits may be painful, but they provide the greatest assurance that your financials are sound and give you a much more accurate picture of the multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) that establishes the selling price for your business.

While the accuracy of your financial statements is paramount, there are a few other financial matters to consider as you prepare to sell your business:

  • Healthy debt. Some business owners believe that they should have a clean balance sheet with little or no debt. The truth is, there is such a thing as healthy debt. To be competitive and make your processes as efficient and profitable as possible, you’ll need to invest in new machine tools and other technology. This kind of reasonable debt makes sense to buyers who will pay more for a company with current technology than one that has no debt, but is behind the competition.
  • Bad debt. On the other hand, if you have serious debt because you aren’t managing your working capital, your inventory is out of control, or you’ve indulged yourself with expensive perks, your asking price for the business will suffer.

When it comes to selling your business, perhaps the greatest benefit of consistently accurate financial statements is the opportunity to demonstrate a historical and predictable EBITDA stream. A buyer will pay more for a company with a sound financial history.

Our next installment looks at the need for insurance and buy-sell agreements.

Succession Planning 6: What Does Insurance Have To Do With Succession Planning?