Editor’s note: This is the second in a series of articles by Cary Silverstein based on a Bridgewood Advisors’ white paper about proactively preparing a business for sale. This article was prepared with assistance of Andy Richter, CPA, CVA, a manager specializing in business services at Scribner Cohen and Co. in Milwaukee.
The importance of preparing accurate and reliable financial statements cannot be understated for a business which may be sold in the future. To achieve this outcome, management and/or ownership should prioritize engaging competent staff to maintain and record financial activity.
Depending on the size, nature, and complexity of the business, this may range from contracting a part-time bookkeeper to establishing an accounting function with several employees. This department may be led by an experienced accountant with a Certified Public Accountant designation. Implementing routine standards and procedures to record financial activity can help prevent, detect and correct errors in financial statements. These practices will improve your company’s ability to generate accurate financial statements imperative for a potential buyer and you, the seller.
Prospective buyers exercise substantial due diligence prior to purchasing a business. This process often includes a thorough analysis of a company’s financial statements. It is not uncommon for potential buyers to request financial statements from the previous five years to analyze trends in a company’s performance. Depending on the facts and circumstances, a buyer may request financial statements which have been “reviewed” or “audited” by an independent accountant. An independent accounting firm issues a report providing varying levels of assurance that the statements are stated in accordance with the required reporting framework. These reports provide potential buyers with comfort to the accuracy of the business’s financial position and historical operating performance.
Preparing reliable financial statements is also important from your perspective as the business owner. Being able to interpret and analyze financial statements is equally important when preparing your company for a sale. Understanding key financial metrics and indicators allows you to drive operational improvements and increase the value of the business prior to sale. A proficient understanding of your company’s financial position and operating performance will allow you to emphasize financial strengths and defend potential weaknesses a buyer may highlight during the negotiation process.
There is no shortage of metrics for gauging the financial health of your business. There are four key perspectives from which financial statements can be analyzed.
Liquidity is the extent to which a business can meet its short-term obligations. Effective cash management practices in conjunction with mitigation of incurring unnecessary payables due to vendors can improve a business’s liquidity ratios, indicating financial strength to potential buyers.
Solvency metrics indicate the extent to which a company leverages long-term debt and is able to meet its related interest and principal obligations. Solvency can be managed through strategically allocating a company’s financing between debt and equity. These ratios also improve when a company generates sufficient earnings before interest and taxes. Strong solvency ratios are positive signals to a buyer as they indicate a company has managed and mitigated its risk of defaulting on debt obligations.
Profitability metrics specific to the nature of a business can be analyzed to assess its ability to generate revenues exceeding its costs. Focusing on generating improved sales of existing products and services while also exploring new sales channels can bolster profitability ratios. Effective cost management promotes improvements in these metrics.
Recurring
net cash flow to equity is one of the primary measures which influences a company’s value. NCFE is the cash a company produces less its related payments for operating activities and debt financing. In other words, it is a company’s cash remaining for business owners. Therefore, it represents the potential return on an owner’s investment in a company. A company’s ability to generate recurring historical NCFE projected to grow in the future directly correlates with a higher business value. Although there is no one-size-fits-all recipe to generate high levels of NCFE, companies with strong liquidity, solvency and profitability profiles usually also generate positive cash flows for their owners.
Prioritizing the preparation of accurate financial statements and understanding how to effectively analyze those statements are crucial components to optimize the price at which you sell your business. Failure to begin this process as early as possible may significantly impede your ability to “get your ducks in order” if an unsolicited offer is made.
