In Part I of our blog series, we emphasized the importance of establishing sound financial statements as a pre-cursor to the ultimate sale of a business. However, merely having good financial statements is not, in and of itself, enough. Understanding the financials and using them in a manner that helps properly reflect actual profits (and the purchase price to be received as part of sale) are really the way to derive real value from financial reporting.
Even well-prepared financials may not tell the whole story with respect to the business and its real profitability and potential earning capacity. How so? Consider that most seller/business owners wisely work very hard to minimize federal, state, and local taxes payable on an annual basis. There are a number of different ways in which seller/business owners might accomplish this objective. Maybe they gave themselves and/or their other family members extra fringe benefits. Maybe they hired their children and included them on the payroll. Maybe they took what would have otherwise been net profit and reinvested it back into certain extraordinary capital improvements related to the business. Maybe the seller/business owner also owns the land and building that the business occupies, and the owner has been receiving rent payments that may not be reflective of a more tenant-friendly market. Of course, the desired outcome in each of the above instances is to reduce the overall profitability of the business, by applying the profit-deflating strategies mentioned above. Were a prospective purchaser to review the owner’s financial statements for a business where one or more of those strategies have been implemented; the purchaser would not appreciate the true profitability of the business. Without a deeper explanation and understanding of the financial statements, the purchaser’s offer would almost certainly be artificially depressed.
What prospective purchasers frequently want to see is a projection of the cash flow potential of the business under their management. In order to do this, the seller and his financial advisors will need to “recast” the financial statements in a way that allows the purchaser to see the true profit potential of the business, without any of the tax planning strategies described above.
The purpose of recasting financial statements is not to mislead a potential purchaser. Rather, the objective is to give the potential purchaser a truer picture of the business he or she is looking to purchase, and to help him or her better understand the business’ profit-generating potential (free of any profit-deflating tax strategies). From the seller/business owner’s perspective, this process of recasting financials helps the seller better understand the true performance of his or her business, and increases the purchase price that the seller can ultimately justify in a sales transaction.
We often aid our clients by working with their other professionals to prepare businesses for sale in a way that would maximize the sale price to be experienced. Call us if we can help.