The Importance of Providing Financial Information for Valuations
You're starting the process of selling your business, and you’ve decided that you want a valuation performed. What information do you provide to the valuation expert?
The seller must provide a number of items for a valuation, and the amount of information can feel overwhelming. Work with an experienced business broker who can help you save time, and can keep the process on track.
You’ll provide a number of documents that explain your business structure, and current organization:
- Articles of incorporation, which explains your structure (C corporation, S corporation, etc.)
- Buy/sell agreements that exist between owners, or with third parties
- Management: Resumes and employee contracts with management
- Organizational chart
Sellers provide a set of financial statements for the past five years, and possibly longer, if the business has operated for a long time.
The statements provided may include both quarterly and annual statements for each fiscal year.
- Balance sheet: Asset, liabilities, and equity reported as of a specific date
- Income statement: Revenue, expenses, and net income (profit) for a specific time period
- Statement of cash flows: Cash inflows and outflows for operations, financing, and investing for a specific time period
- Notes to the financial statements: The notes include the accounting principles used to generate the financial statements, and other disclosures
Valuation experts use the financial statements to analyze company liquidity and solvency. Liquidity is a firm’s ability to generate sufficient current assets to pay all current liabilities.
Solvency, on the other hand, has a long-term focus. A company’s solvency refers to the ability to generate revenue over the long-term to purchase expensive assets, and to pay down debt.
A valuation specialist compares the financial results over a period of years to identify trends. For example, if the accounts receivable balance is growing at a faster percentage rate than sales, the trend may be an indication that the business will eventually run short on cash.
The expert will also review company tax returns, including any amended returns. Income in the financial statements may be different from income reported on the tax return, and the differences are documented on the tax return.
A pass-through entity, such as a partnership or S-corporation, passes profits and losses to the personal tax returns of the owners. The entity will report total earnings on the tax return, and the ownership details.
The valuation analyst may make adjustments to the financial statements.
Adjustments to the Financial Statements
Adjustments are posted so that the financial statements comply with accounting principles, and so the records only include the assets and liabilities that are being sold.
- Assets and liabilities: The balance sheet is adjusted for assets and liabilities that are not part of the sale.
- Non-recurring items: Income and expense items that are unusual, such as a gain on an asset sale, may be removed.
- Owner’s salaries: These salaries may be removed, because the current owners will not be with the firm after sale.
- Bad debt expense: If accounts receivable balances are determined to be uncollectible, the balance will be reclassified to bad debt expense.
- Related party transactions: The financial statements must disclose transactions that are not completed as an “arms-length”, or third party exchange. If an owner’s son supplies $100,000 in raw materials to the business, the related party transaction must be disclosed.
Inspection of physical assets
The individual performing the valuation will physically inspect machinery, equipment, property, and inventory, to confirm that the assets exist. You must provide your most recent property tax assessment, and any appraisals performed on the assets.
Payroll is a large portion of a firm’s costs, and the valuation analyst uses several reports related to payroll:
- Payroll data on employees, and gross wages, along with 1099s issued to contractors
- Employee benefit plans: Type of plans offered, and costs paid by the employer and the employee (including health insurance and retirement plans, such as a 401(k) plan)
- ESOP plan: Shares issued to employees, and the dollar amount of funding in the plan
- Incentive compensation: Profit sharing plans, stock option plans
- Key employee life insurance: Life insurance in force on the lives of company managers, including the face amount of each policy, and the premiums paid for coverage
Valuation analysis requires you to provide contracts.
You may have contracts with vendors, customers, and possibly non-compete agreements. Provide any loan documents you have, and lease agreements. If you have agreements to distribute a product, or operate as a franchisee, provide those agreements, also.
Submit documents regarding ownership of intellectual property (IP), or agreements that allow you to use another party’s IP.
Many businesses deal with legal issues and contingencies. Work with your attorney to disclose any liens, tax matters, pending litigation, or regulatory issues.
Business plans and forecasts
Provide any budgets, forecasts, projections, or business plans that you use to make management decisions. Here are some related items to submit:
- Revenue generated from your top 10 customers (May be produced for the last several years)
- Top 10 purchase amounts listed by supplier
- Information regarding the possible loss of a product line, distributorship, customer, supplier, or financial source
- Information regarding the possible addition of a product line, distributorship, customer, supplier, or financial source
- Any key employees who have recently left, and the impact of the departure on your firm (customer relationships, number of people managed)
- Pending acquisitions
If you need a valuation performed, work with a business broker who can manage the data collection process.
A Trusted Advisor
Raincatcher has the experience and professional connections to ensure that your business is valued properly. They use industry-leading proprietary valuation resources to value your business and support the proposed sale price.
Your Raincatcher business broker will be your trusted advisor throughout the sale process. Your business sale involves a group of professionals, which may include a valuation expert, accountants, an attorney, and a business broker.
Work with Raincatcher, and sell your business with confidence.
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