6 minute read

Cleaning Up Financial Statements for Accurate Business Valuation

You don’t want to put all your effort into building a business, then after cashing out, realize you sold it for much less than it was worth. If you take time before the sale to adjust or clean up your financial statements for an accurate valuation, you can make sure this doesn’t happen.

Accurate and clean business financials along with recast financial statements are the foundational documents for a business valuation. Entrepreneurs, startups, and long-time business owners ready to sell need to put their company in the best financial position with strong business finances to get the biggest return on investment.

Read on to discover the importance of accurate financial statements, strategies to recast financial statements to capture the true worth of your business, and how to use industry benchmarks for maximum value.

Importance of Accurate Financial Statements in Business Valuation

As a seller, you want the best price for your business. But this largely depends on your business financial valuation. A high valuation gives you more bargaining power, especially for setting the price.

A valuation is only as good as the company’s financial statements. First, you need accurate and reliable financial records. This starts with verifying that your accounting software is up to date for correct calculations.

Clean financials can help a buyer identify the strengths (and weaknesses) of your business, predict future performance, and assess risk to make informed decisions.

Preparing and presenting financial statements should be as transparent as possible, preferably using U.S. generally accepted accounting principles (GAAP). And having robust financial management procedures and controls will help. Otherwise, potential buyers may easily back out if they notice any dishonesty or financial manipulation.

When to Clean Business Financials Before Selling

There’s no rule for when to clean up financials before selling your small business. Consider starting your due diligence and clean up at least two to three years before the intended sale date. Buyers of small businesses with values of less than $5 million typically request several years of historical financial reports.

Potential buyers may also ask for previous tax returns to confirm you’ve made tax filings on time and evaluate any tax liability your company may have.

Strategies to Recast Financial Statements

Your financial statements, including your balance sheet, income statement, and cash flow statement, will be the source for your recast financials.

Recast financial statements remove one time and non-recurring expenses and normalize periodic expenses.

Adjust for Non-Recurring Expenses

Remove business expenses that aren’t expected to occur in the future. This can be an insurance payout, a litigation expense, or costs related to a specific project or event.

Since these items are unlikely to happen again, they are irrelevant in forecasting the business’s future performance.

Address Owner’s Compensation and Benefits

Adjust the business owner’s salary and benefits to reflect current market rates. The assumption here is that the buyer will need to pay market rates for new management.

Make Revenue Adjustments, if Necessary

Ensure revenue is recorded in the correct period and reflect earning patterns. Adjustments could be for one-time sales or special orders.

Review Non-Operating Revenue

Take out any revenue not related to the core business operations, such as interest income or gains on selling assets.

Sum up Discretionary Expenses

Remove and make a separate list of discretionary expenses. These are costs that may not be necessary to operate the business like travel, memberships, or subscriptions.

Impact on Financial Statements and Valuation

While a buyer will want to review your financial statements, a set of recast financials will help the buyer understand the business’s financial health and potential future performance.

They will also want to know about the adjustments made, so make your recast financial statements outside of your bookkeeping or accounting system. Consider using Microsoft Excel and ask your CPA if they have a template.

Leveraging Industry Benchmarks in Financial Cleanup

While doing a financial cleanup with a sale on the horizon, make use of industry benchmarks or pricing multiples, to improve the efficiency and performance of your business to increase its value.

The following are some common benchmarks you should leverage.

• Rent as a percentage of revenue: This metric, expressed as (Rent expense ÷ Gross revenue) × 100, can help you understand how your rent expense compares with similar businesses so you can negotiate with your landlord or consider moving to a more cost-effective area.
• Cost of goods sold (COGS): Benchmarking cost of goods sold can help owners assess gross profit margins and consider increasing sale prices or reviewing product input costs.
• Labor costs: Benchmarking labor costs can help small business owners improve efficiency by considering options such as upskilling workers, reducing headcounts, or improving the quality of inputs staff use.
• Profit margins: Comparing your profit margins with those in the industry can help you focus on increasing your pricing or lowering either your operating or direct costs.

Remember, to maximize the value of your business, analyze industry benchmarks years before the intended sale.

The Takeaway

Your financial reports should be accurate before you sell your business. And your recast financials should help capture future reality by making adjustments for non-recurring items.

Do you want to delve deeper to prepare for a business sale and understand more about clean business financials? Visit BizBuySell's Valuation Learning Center for more information or discover what your business is worth using BizBuySell's valuation tools.

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