For many of us, the end of the year is a time for reflection—and for most businesses, it is a critical juncture. Owners look back on the previous year and forward to the year ahead, with an eye toward making necessary tweaks and building on past success. Now is the time to prepare for the future, especially if you’re considering the sale of your business.
While closing this year’s books, you can evaluate where things stand and determine how to increase profits and proceeds from a potential sale - a process called recasting. Taking steps today to monitor your profits and working capital will pay off when prospective buyers perform due diligence, hoping to reduce the purchase price. As a result, having your financial statements clean and in tip-top shape will help sustain your business’s value during the grueling due diligence process, so you can achieve your goals and benefit financially when you decide to sell.
The following describes steps any business owner can and should take to increase total value and proceeds.
Identify Your Owner’s Perks
When selling your company, the work you do today will pay significant dividends during the sale process—especially when it comes to capturing information about personal and one-time expenses, so you can maximize your business’s value and validate these critical items during due diligence. In reviewing your business accounts, consider whether any of the year’s business expenses should be categorized as owner’s perquisites: goods and services you receive as owner of the business. Create a log that records all auto expenses, travel, entertainment, and excessive compensation, whether they are ongoing or were incurred only once. Identifying these owner’s perks is imperative, as they should be eliminated from your business’s expenses in order to determine a dependable EBITDA—and maximize the value of your business when you sell.
Recasting personal and one-time expenditures each month will allow you to establish a baseline EBITDA for a 12-month period, which will be used to take your company to market. As you review credit card statements, invoices, receipts, and so forth, track the purpose of these expenses and when they occurred. Also keep a file with any backup documentation that proves the expense is indeed personal and/or one-time only. Compiling this information demonstrates to a buyer that these expenses are not part of your regular business operations and will increase your purchase price. Refer to our article Identifying Add-Backs for more information on items to consider when determining which owner’s benefits apply to you.
Determine Your Net Working Capital
Reviewing your business’s assets and liabilities will reveal the amount of net working capital required to meet your revenue and growth projections. When preparing to sell your business, a clean basis for establishing such a target ensures the business runs as it normally would. Many business owners fail to minimize working capital because they want to take advantage of buying opportunities that increase inventory or discounts that decrease payables. But if you can run your company with less working capital, you need to demonstrate that now. Remember, the more working capital you can convert into cash prior to a sale, the more proceeds you get to keep once the sale is complete. For more details, refer to our article How Net Working Capital Impacts the Value of Your Business.
What Are Your Current Assets?
Accounts Receivable
Your business’s accounts receivable records are vital to establishing a reliable history of your business’s revenues, and analyzing them carefully will normalize the effect of any bad debt expenses your business may have. When reviewing all your outstanding accounts receivable, evaluate the customer history to ascertain a typical payment pattern and determine whether any of these balances are uncollectible. If an account is uncollectible, consider adding the balance to your bad debt reserve. A buyer may deem invalid any accounts receivable that appear uncollectible and may remove these accounts from consideration. To avoid a diligence issue and help ensure a smooth sale process, it’s best to stay in front of this by writing off any of these outstanding, uncollectible accounts receivable.
Throughout the process of selling your business, an assessment of the monthly accounts receivable aging reports will help determine your average monthly balances. Assessing these accounts regularly will make this process easier and will inspire confidence in their accuracy.
Inventory
Reconciling your inventory can be an especially challenging task, but the benefits of maintaining a perpetual inventory system are substantial. An inventory software system can streamline this process and be a significant time-saver, but an annual physical count is always best. At the end of the year, you want a report that indicates each piece of inventory and if that item is still saleable. Demonstrating the ability to support revenue with a minimal level of inventory will show buyers you can be profitable while also being efficient in your use of working capital.
What Are Your Current Liabilities?
Accounts Payable
In reviewing your business’s accounts payable reports, examine all your invoices for goods purchased to ensure they are captured in the proper period. Include any invoices you have received for orders placed but goods not yet received, and adequately mark all invoices as paid versus unpaid so your financial statements will be correct. Buyers will be reviewing both your payment history prior to entering a sale process and your actions throughout the entire process, looking to confirm you are not delaying payables to reduce your immediate working capital needs, so paying these vendors in your normal manner is crucial. If you have taken discounts in the past, consider stopping this practice and paying on time instead of early. This will reduce your working capital needs and help demonstrate to a buyer that your business can operate with less.
Accrued Expenses
Reviewing and identifying other business accruals for correct accounting is just as necessary. Be sure to adjust other current liabilities such as year-end and holiday bonuses, vacation time, or paid time off. Although these items should be accrued monthly, your year-end accounting can be a perfect time to make amends and start accruing for these regularly. After all, a potential buyer will want to see these accruals on the balance sheet.
If your employees are accustomed to receiving bonuses at this time of year, a potential buyer will need to continue this tradition in order to retain key personnel. Any buyer will expect this accrual to be in place when determining the amount of your accrued expenses, so reviewing and accruing bonuses monthly will streamline this process. Otherwise, the buyer will likely request an adjustment for these bonuses.
Also examine your vacation or paid-time-off policy; if your employees cannot roll over any unused time into the following year, this account will be zero at year-end. If employees are allowed to roll over any time, however, make sure you accrue for this future liability to reflect the obligations of your business adequately.
Find Certainty in Your Sale Process
All serious buyers will obtain a quality of earnings report from an accounting firm, which reviews your financial statements in depth to ensure the items mentioned throughout this article are reconciled as they should be. The fewer adjustments the auditing firm needs to address, the more certainty you have as a business owner that the transaction will close as outlined in your Letter of Intent. What’s more, a thorough scrub of your financial statements lowers the risk of substantial adjustments to your purchase price.
Steps like these seem minor when completing your year-end accounting, yet they are crucial in the eyes of potential buyers or creditors. Establishing monthly and annual routines, as described here, makes it easier to capitalize on whatever future growth or exit strategies you choose.
PCE has helped many companies prepare for the sale process. If you have any questions, please contact us.
