Putting Your Best Foot Forward – Strengthening Your Accounting Records
Guiding business owners through our exit planning program, we always begin our discussion with a review of their financial records. Business owners are interested in selling their businesses, but their accounting records are many times not up to par. There are many levels of business acumen and financial knowledge, of course, and we oftentimes have conversations like this:
Us: “Please describe how you leverage your financial records to make business decisions?” Owner: “Oh, I have my online banking on my phone, and I can see all of my transactions. We download the transactions into Quickbooks, and we can see what expenses were paid and what cash we received from customers. I can see how much money I’m making, too, which is great.” Us: “That’s great. How do you review your financial statements to help you make operating decisions for your business?” Owner: “Our bookkeeper prints off the financial statements and tells us how much revenue we did and how much money we made. We know our business, so we make decisions based on how much cash we have and how many sales we made.”
Obviously, I’m oversimplifying a common problem, but we’ve found that many business owners are not unleashing the power of their financials, using the information in their accounting records to make effective business and operational decisions. It is even more simple than that.
Most business owners are not professional accountants, let alone CFOs. It goes with the territory. An idea sparked a business, and the owner rolled up their sleeves to make it happen. Keeping up the books was a necessary evil to do their taxes, and it often got in the way of building and expanding the business, meeting new and existing customers, and dealing with employee development issues.
As the business continued to grow, the books did not grow with it. While many of our clients are on Quickbooks or Xero, both cloud-based accounting software applications, which is a start, they’re using the cash basis of accounting to record their transactions. This does not give you an accurate picture month-to-month of your revenue and expenses, which should be matched at the time the transaction occurs, not when cash is received or payments are made. This is vitally important.
For example, let’s say that you make your rent payment on a monthly basis for next month’s rent, and in one month, you paid two rent payments to the landlord. In one month, you would show no rent expense, and your profits would be too high. The next month, you’d have two payments of rent hitting the books, and your profits would be artificially deflated. Proper accounting would have you create a Prepaid Rent account for the next month’s rent that you paid in the current month, which would properly reverse the following month. That reversal would also record the rent expense in the proper month. By doing your accounting this way – using the accrual method – you have a proper view of revenue and expenses on your Income Statement (also called the “Profit & Loss Statement”), and your Balance Sheet is accurately presented as well.
One of the steps in our Reach Your PEAK exit planning system is performing an assessment of our customer’s accounting records, which oftentimes requires a clean-up effort. It’s critical that business owner’s use the accrual method of accounting when recording their financial transactions, as we discussed. It’s even more important that their accounting records are accurate, complete and defendable, especially when you put your company on the market for sale.
Why is that?
Buyers look at a prospectus that presents the company for sale, and the prospectus includes financial statements and other accounting data to highlight a company’s financial performance. Most buyers and their advisors are savvy business people, and they’ll have a strong foundation in finance and accounting. Your financial statements are like your resume that you present for a job. If you’re resume has typos and grammatical errors, it will get thrown in the waste basket, even if you were the most qualified person for the position. Much like a resume, your financial and accounting records are your best representation of your company and its financial performance over time. If there are inconsistencies and inaccuracies in your financial statement presentation, interested buyers will have a lot of questions, often renegotiating the Seller’s asking price down or walking away entirely.
It’s food for thought.