introduction
Having a Clean Report
Your sales presentation to a prospective buyer will include the company financials for the past 3-5 years. Therefore, you should always prep your business to show a 2 or more years upward-trend that supports your market value.
We will review the financial requirements needed to secure the maximum value for your business. Our topics:
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financial reporting prep #1
analyze the income statements
This is an expected requirement before any business will sell. If your sales are trending down, it's best to revisit your marketing strategy prior to listing your business (unless your strategy is to exit the business at any price).
The buyer will analyze the sales numbers. They will want to know what strategy you have in place that will support these sales figures when you transfer the business over to them.
Additionally, the buyer will want to know:
If your business brand, product, customer contacts, etc., are dependent upon your management, you must prep your business to carve yourself out of the picture by:
The second line item the buyer will scrutinize is your expense items. They want to see expenses that are strategically managed — in other words, expenses incurred must support the operating business and marketing strategy.
Frivolous expenses only raise questions about your financial assumptions.
Prep your business by removing:
Prep your business by documenting:
financial reporting prep #2
how do you classify company assets
Selling the company means selling the company assets. The buyer is only going to pay for income-producing assets.
Current assets include the following:
The buyer wants to see collectible receivables dated no longer than 30 days or within industry standards. Invoices or receivables dated more than 30 days indicate sloppy management and/or troubled collections.
The buyer will evaluate your inventory management. Dated inventory may be worthless in the eyes of the buyer, regardless of book value. If you can't sell the inventory, the buyer doesn't want it.
Short-term notes generally include loans made by the company to the owner or owner's family.
What are the fixed assets:
— leasehold improvements
— furniture and fixtures
— equipment (machinery and tools)
— company vehicles
— building(s)
— land
— other
Fixed assets that should be included in the sale are those assets that are income-producing:
financial reporting prep #3
reviewing the company liabilities
Selling a company comes with its obligations. The obligations that should be included are those line items that produce income.
Current liabilities include the following:
The buyer wants to see payable accounts that support the day-to-day operations of the company. These accounts should be paid on-time, taking advantage of discounts and other payable perks.
Short-term notes include loans that must be paid back within 5-7 years. These loans should be exclusively tied to the operating needs of the company.
What are the long-term liabilities:
— long-term notes for building and land
— long-term notes for equipment
— other long-term notes
— other
In most cases, buyers will only assume those obligations that are directly tied to the income-producing assets of the company, such as operating equipment.
Buyers generally will not buy the land and building if it is owned by the seller. Including the real estate in the sale will increase the cost to the buyer while keeping the company earnings at the same level. The buyer's going cash position will be decreased making the business less attractive.
financial reporting prep #5
finding true cash value
Documented business financials are "minimized" to show as little taxable income as possible. The company's true economic value is generally greater than the reported taxable value.
To derive the economic value of a company, you need to recast the financials to show the company's true economic value.
Market value reflects the cost to replace a piece of a equipment or asset to its current state minus its wear
Another related line item is the owner's salary and perks. You need to add back owner salary and perks to reflect the true financial cash position of the company.
Recasting the financials reflects the true economic value of the business, prior to depreciation, non-operating interest charges, owner salary and perks, and non-recurring expenses.
financial reporting prep #6
calculate the cash flow position
The cash flow position must support the asking price. Think about it.
If you were going to invest $100K as a down payment to buy a company, the return of your investment needs to equal a cash return that is greater than the return if you invested the down payment in the equity markets.
Additionally, if you were going to expense your "sweat equity" to manage and grow the business, the cash return must be greater in value than finding a job that would give you equal value.
That is why cash is a determinant factor when making a business purchase.
Take the: company's discretionary cash flow |
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Reduce this by: Annual debt service Owner or manager annual salary Capital Expenditures Return on Down Payment |
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Equals: Remaining Cash Flow |
Example:
Estimated Sale Price: | $450,000 |
Buyer Down Payment @ 33%: | $150,000 |
Business Financing @ 67%: | $300,000 10.0% 7-Yr Note |
Market Value of Operating Assets: | $50,000 |
Estimated Return on Down Payment: | 5.0% |
Annual Sustainable Cash Flow: | $175,000 |
Less: Debt Service | $59,764 |
Less: Debt Service Cushion @20% | $11,953 |
Less: Annual Capital Expenditures | $5,000 |
Less: Return on Down Payment | $7,500 |
Less: Owner's Salary | $80,000 |
Cash Flow Coverage: | $10,783 |
The example shows that the buyer's "down-payment" and "sweat equity" will generate a positive cash position after paying financing costs and deducting a cash salary.
*Note: Standard cushion required by lenders when underwriting this loan. This amount covers the cost of financing in the event of economic or market turn-down. The amount is not an expense and would be an additional amount to cash flow.
Increasing cash flow requires an
Maintaining a steady flow of sales requires a supporting marketing strategy. View our business marketing model on market planning and growth
financial reporting prep #7
what will the company look like in 3 years
The buyer needs to understand the expected projections over the next 3 years.
You generally achieve this by showing the growth projection made over the last three years and continue that trend going forward.
A more supporting projection can be made from a well-planned marketing strategy as discussed under our market expansion plays.
It is up to the buyer to calculate the effects of competition, economic conditions, the prevailing market, and what the buyer can accomplish.
The 3-year forecast should reflect income before depreciation, non-business expenses and owner salary and perks.
Krayton M Davis Executive Director, CFOne Business Advisory Services Serving Richmond and Northern VA 1-571-306-3590 or e-mail your inquiry to: |
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Krayton M Davis Executive Director, CFOne Business Advisory Services Serving Richmond and Northern VA 1-571-306-3590 or e-mail your inquiry to: |
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