As a small business owner, you probably have a love-hate relationship with your business financials.
Many of the owners we work with are focused on running their business and only have financials because the IRS requires it. If that’s you, then this blog is for you.
Financials are one of the most important pieces of information a buyer will receive about your business. Having them clean not only makes the deal smoother and faster, it might be the difference between being able to sell your business at all and not.
At MidStreet, we’ve worked with hundreds of business owners to clean up their books before a sale. We’ll cover the most important things you can do to prepare your books for a sale in this blog.
Disclaimer: Although effort has been made in providing accurate information, MidStreet does not warrant that accuracy and is not liable for any errors or omissions. MidStreet, nor its employees, are licensed tax professionals or attorneys. Readers are strongly encouraged to confirm tax and legal issues with accountants and attorneys in your respective state or province. The article is based on information as of spring 2022.
4 Steps to Clean Up Your Financials For a Sale
When it comes to cleaning up your financials, it is best to start well in advance of when you want to sell. If you start making positive changes to your financials 1-3 years out from the sale of your business, you can improve your chances of getting the best price and terms for your company.
It is our experience that buyers will request 3 to 5 years of financials in most small business sales. In the majority of sales under $5 million in value, it is only 3 years.
The SBA 7(a) loan program, the most popular way to finance small businesses, requires 3 years of tax returns. We highly recommend all business owners clean up their books as soon as they start to think about selling, even if they are 5 years out.
1. Clean Up Your Books to Follow Accepted Accounting Norms
While the tax code is very complex, it does afford you, as a small business owner, a lot of freedom in how you run your business. This freedom often leads to unique decisions on how to report the income and expenses.
For a buyer to feel comfortable and to secure financing, they’ll need to understand exactly what your financial statements mean. This means knowing the nitty-gritty details on how your business financials are put together.
The first step is for a buyer to know what “basis” your financials are prepared on. Meaning, do you use a cash basis or an accrual basis of accounting? Or, does your business operate somewhere in the middle?
You’ll want to pick either cash or accrual basis at the recommendation of your accountant. The best-case scenario during the sale is to have both, regardless of which you use on your tax return.
Imagine you own a roofing company - when do you record revenue in your books? When you complete the job? When you send the invoice? Or when the customer actually pays?
By following a set accounting basis, buyers will have a consistent way to look at your business.
Other common things we see that are best remedied are:
- Having multiple accounts for the same thing- such as two meal accounts
- Changing account names year to year
- Not having rules on when you expense purchases vs capitalize purchases
- Having your P&Ls and balance sheets in an outdated or hard to read format
- Not having copies of your full tax returns with all schedules
A good strategy is to talk with your CPA about your internal accounting processes. They will be able to advise you on the generally accepted accounting norms that you should follow. You will also want to have written procedures for how and when you do certain financial actions such as:
- What are customer payment terms?
- When is revenue recognized?
- Who prepares the tax returns and what information do you provide them?
2. Remove Non-Operating Assets From Your Balance Sheet
Over the years your business might have purchased and sold a lot of equipment, trailers, and vehicles. If you have sold vehicles or no longer use vehicles for business purposes, you should remove them from your balance sheet.
Removing these items from the balance sheet will help buyers get an idea of what assets are needed to run the business. You should also remove personal property from the business, for example, a personal vehicle or boat.
Overall, you will remove these non-operating assets from your balance sheet to clean up your depreciation schedule. You want your balance sheet to only have the assets you plan on including in the sale.
3. Reduce Discretionary Personal Purchases Through The Business
If your business is going to go through the SBA 7(a) loan process (businesses under $5 million in sales price often do), you will want to reduce discretionary spending.
SBA lenders can be tough about giving you credit for discretionary items, or at a minimum may request that you provide solid documentation regarding those expenses.
To avoid this issue, you can do the following:
- Limit meals and travel to what is necessary for the business
- Avoid using the business to pay for personal items
- Don’t pay family members who don’t work at the business
- And any other non-business use of business money
It is always best to err on the side of caution when preparing your financials for the sale of your company. To get professional advice on the best tax protocols, reach out to your CPA.
4. Make Sure Your Profit and Loss Statements Match Your Tax Returns
The SBA requires that your profit and loss (P&L) statements match your tax returns. In order to get these documents to match, you may need to recruit the help of your CPA.
Some reasons your P&L and tax return might not match include:
- Your tax return and your P&L do not have the same basis
- Year-end adjustments are made on your tax return but not on your P&L
If you or your valuation specialist notices that these reports do not match, you should get them fixed right away to ensure they’re ready when the selling process starts.
Clean Up Your Financials and Sell Successfully
By cleaning up your financials according to accounting standards, removing non-operating assets from your balance sheet, reducing discretionary personal purchases through the business, and making your P&L and tax return match, you will make the selling process easier.
After your financials are cleaned up, the next step is to get a business valuation performed. To learn what a business valuation is, read “What is a Business Valuation? (And Which Type Is Right for You).”
Knowing how to prepare to sell your business can be difficult. If you have any questions about selling your business and how to prepare, give us a call today.