A snap-shot of Financial Performance
One of the first things a buyer does when faced with a potential business that meets his, or her financial and lifestyle criteria, is to consider the following factors:
- How much money could I make with this business?
- How much is the current owner taking home from the business?
- How much has the owner taken in recent years?
- What is the likelihood of this cash flow continuing?
- What are the prospects for growth?
- How many competitors are competing in your market place?
- Why are you selling?
The answer to these questions will ultimately determine if a potential buyer will move on to the investigative stage (the formal “Due Diligence” phase), or not.
The vendor’s ability to answer these questions concisely and clearly is very important in keeping a serious and qualified buyer interested. Therefore, having an easy to read “snap-shot” of historical and probable future financial performance is fundamental to the process of selling a business.
The process of recasting financial statements is essential in determining the value of a business when the owner’s intention is to sell. Recasting requires extensive investigation to ensure that all relevant and appropriate adjustments are correctly reported.
Most business owners diligently minimize their overall tax exposure and maximize the benefits that come with business ownership and that is just solid, practical business management.
Recasting financial statements to reflect the Owner’s Adjusted Cash Flow, (often referred to as, Sellers Discretionary Earnings, “SDE”), is essential in answering the Buyer’s burning questions about the cash flow of the business. Accordingly, the historical financial statements and future forecasted income/expense to develop a year by year Adjusted Cash Flow Comparative Summary, (a “snap- shot”, if you will), of past, present and probable future financial results, need to be examined. Determining Adjusted Cash Flow requires extensive investigation and analysis to ensure that all relevant and appropriate adjustments and “ add – backs” are calculated correctly.
The recasting process identifies items such as owner’s benefits and excessive and/or discretionary expenses, personal vehicle expenses, personal insurances, wages to family members for income splitting purposes, perks, incentives/bonuses, personal travel, loans to affiliates and so forth. There may also be one time non-recurring revenues and expenses such as bad debt, unusual major repairs, or one time sale of assets and the like. Finally, there are non-cash items to be taken into account such as amortization and depreciation. Recasting this financial information into a comparative financial summary provides an easy overall view of the company, and facilitates meaningful evaluations of year-by-year performance, as well as simplifying comparisons with other investment opportunities that the buyer may also be considering.
Accountant prepared year-end financial statements, income statements, balance sheets, cash flow statements and notes do tell the whole “story”, however, the challenge for a buyer is to qualify the answers they are seeking as to “how much money could one potentially take home from this business”. These answers are not always easily apparent from a quick overview of the financial statements. The year-end statements are often produced with a strategy in mind to reduce profit (taxable income), and not necessarily to highlight all of the benefits the owner is deriving from the business.
Many details must be considered during the process of determining value and selling a business. Recasting the financial statements to create an Adjusted Cash Flow Comparative Summary is one important key indicator of Market Value, and guides the owner by setting realistic expectations of what the business is worth.
Although recasting clearly plays a pivotal role in a business valuation, it alone does not determine the total value of any given company. A business valuation is far more comprehensive and furthermore, takes into consideration the intangible value of the company’s goodwill, copyrights, trademarks, patents, proprietary products and processes, as well as other relevant factors. Finally, remember that the industry your company falls under and short and long-term economic forecasts for the industry, are also potentially taken into account by a savvy prospective buyer and are out of the Vendor’s control. Thorough preparation on the vendor’s part however, can go a long way in countering any perceived negativity caused by a fluctuating marketplace.