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How to Prepare Financials for Business Sale

Don't show buyers your Trading Financial Statements without first preparing a Normalised set of financials (also referred to as Adjusted Financials).

If you rely only on your Accountant’s financials or Tax figures to sell your business this can lose you potentially hundreds of thousands of dollars in sale price. Accountants typically prepare your financial statements to minimise your tax liability which will generally show the lowest possible trading net profit for your business.

We show you how you can increase your Trading Net Profit!

Using your Accountant prepared Profit and Loss Statement, identity expenses paid by the business which are either of a personal nature or a one-off expense (i.e. an expense that is extraordinary and in normal trading periods will not be incurred again). These expenses can be ADDED back to your Net Profit in an Addback Schedule to raise your bottom line; or in other words, removed from your Operating Expenses as they were either of a personal nature or a one-off expense which are unlikely to be incurred by another business owner.

An Addback Schedule will allow a buyer and their financial adviser the ability to appreciate the actual operating profits of the business before personal expenses and salaries of the business owners/directors. All financial institutions including banks take into account and fully accept items listed as Addbacks, providing the add-backs can be verified and are reasonable.

Based on historical business sales, we show you an example of how you might adjust your Profit and Loss Statement for Addbacks/Adjustments.

Scenario:

Company XYZ offers a roof restoration service that requires the purchase of goods to perform their service. The business operates with two owners working full time. One works in a more technical role, the other in an administrative role. Most good Accountants and Lenders will expect to see a normalised set of financials that show the trading income to one working owner. Therefore, the other working owner should be “replaced” with “staff” paid at the equivalent rate for the industry and position. To satisfy this criterion we “replace” the owner who is working in the administrative role rather than the owner who is technically involved. They also own the Freehold property in which they operate the business and have not paid rent.

Some points to consider:

Note
Accounting Entry Comments
1 Other Income It is generally not accepted to include other income which is not part of the normal activities of the business to generate income (e.g. Interest earned, income from selling assets, income from rental property etc.).
2 Accounting Consider whether you have asked your Accountant to perform extra activities over and above what is required during normal trade, or whether your Accountant manages multiple accounts for you etc. Extraneous Accounting fees that are not part of normal trade can be added back to your profit.
3 Bad Debts Consider whether the Bad Debt is a once off occurrence. If your business can demonstrate that you have successfully removed Bad Debts from your business, then you can add the Bad Debt expense back onto the profit. It is generally not acceptable to add Bad Debt to your profit if it is likely to recur.
4 Motor Vehicles It is generally acceptable to addback (or partially addback) motor vehicle expenses that are of a private nature including insurance, depreciation, registration etc. It is generally not acceptable to add Motor Vehicles to your profit if it is required for normal trade.
5 Depreciation - Plant & Equipment Depreciation is an accounting entry for tax purposes and is not an out of pocket cash expense. Depreciation is often added back where the business does not rely heavily on the plant and equipment to operate the business (e.g. office furniture). If you own a manufacturing business where plant and equipment is key to the business, then it is generally not accepted to add depreciation back to the profit as you will need to replace the equipment at some stage.
6 Rent Consider whether the appropriate amount of rent has been factored into the expenses and adjust the rent amount up or down in your Addback Schedule depending on whether the appropriate amount has been paid. If you own the property and are considering renting the premises to the incoming business owners, then you should also look at including a rent amount that you would accept as the landlord. This amount should be included as a trading expense as it will be incurred by the incoming owners during normal trade.
7 Director's Allowance Consider the amount of normal hours worked by each owner. If there are NO working owners in the business, and the owners take a wage from the business, then it is acceptable to add back the wages (and superannuation) for all non-working owners (i.e. the business demonstrates that it can run day to day by staff with no day to day owner involvement).

If there are owners working more than normal hours (i.e. more than 38hours to 40hours per week), then an adjustment should be made to reflect staff taking the extra hours calculated at a rate equivalent for the role.

The Trading Net Profit should reflect either: (a) a business operating Under Management or, (b) a business operating with one owner working normal hours (additional working owners should be adjusted in the financials for staff taking the extra hours required to run the business, and calculated at a rate equivalent for the role).

General Comments:
Certain expenses can fluctuate substantially from year to year (e.g. Bank Fees, Advertising and Marketing, Wages etc.). Although it may be an event that cost you money, it was a necessary expense which you incurred in order to make sales (even if you considered it a financial disaster due to a less than desirable sales outcome), and therefore can NOT be added back to your profit. Businesses that can identify the reasons for these fluctuations and are able to improve and control these expenses can be in much stronger financial positions.

Having said this, it is worth noting that a substantial increase in certain expenses is not necessarily something to be alarmed about. Whilst the dollar amount has increased, the impact of the expense may remain relatively unchanged in percentage terms (a common expense that can jump in dollar terms is Purchases but when compared from year to year in percentages, the figures may remain relatively stable and therefore would ordinarily not be a cause for concern).

It is best to have your Accountant prepare the Addback Schedule. If you only have interim financials (or year-to-date), then it is quite acceptable to use your Management Profit and Loss Statement.

Please note that any addbacks and/or adjustments should be made in consultation with your financial advisor and the above suggestions have been offered as points for consideration.


 

Copyright. This material has been written by BizClassifieds and is not to be used or duplicated in part or full.

Disclaimer:

The information provided above is to be used as a guide only. No person should rely on this information. BizClassifieds recommends persons seek their own professional advice, and accepts no liability for any loss or damage which any person or business may suffer arising from any negligence on our part.