What does it mean to “clean up” my financial statements?
So you are interested in marketing your business?
One of the first Buyer questions is “send me your financial statements.” Buyers want clean financial statements, but what does “clean” actually mean? The traditional meaning is “in compliance with generally accepted accounting standards (“GAAP”), consistently applied.” Short of having a full-time CFO, most middle market businesses do not have the manpower to apply GAAP. Here are the top comments we receive from buyers, presented in the spirit to help you to get as near compliant as practical:
Inadequate accruals. Buyers often comment that expenses are only recognized when paid. It is a good practice to accrue your major expenses. For example, if property tax is $12,000 per year, the business should record a monthly expense of $1,000.
Inventory is incorrectly stated. Inventory issues can take many guises, ranging from weak systems to no write-off of obsolete inventory. Many smaller businesses take an annual inventory and then adjust the financials to agree to the count once each year. A better idea is to implement a perpetual inventory system to record the movements in inventory. Write-off or reserve for obsolete or slow-moving inventory now.
Accounts receivable-are they collectible? Consider evaluating your over 60-day receivables each month; write off or reserve for those you probably will not collect.
Not accounting for off-balance sheet obligations. Most of us make some kind of promises and commitments to customers, employees, and other stakeholders. For example, if you have promised your sales team a tropical cruise if certain goals are achieved, you should consider recording that obligation.
Lack of meaningful business intelligence. Every operator I have met “knows” his customers, suppliers, and products. But when asked for actual data, many are at a loss. For example, buyers routinely request a list of top 20 customers by year, along with sales and margins.
Tax return is significantly different from financial statements. Many buyers request tax returns because tax returns are signed under oath. A frequently seen comment is unexplained differences between book and tax; the usual reason is that the books treated an event differently than tax. Sometimes this is necessary, but the closer the two reconcile, the better.
No footnotes. GAAP financials include footnotes to describe accounting policies, explain business policies and practices, and other key matters.
If you are thinking of selling your business, discuss your financial statements with your CPA. Ask about these and other company-specific issues and seek advice on complying with GAAP.
We at Sweetwater will offer you a complimentary consultation on this and other transaction matters. Please send us your thoughts, comments, and questions.