Suppose you’ve decided to exit, sell the business. In a sense, quit your job. Just how do you sell a business? Preparation is paramount: take a look at some financial statements for selling a business.
What financial documents do you need?
Following are financial documents you will need when selling your business, including, among others, a business financial statement. Financial statements are written records of a business’s current financial position. They include standard reports like the balance sheet, income, profit and loss statements, and cash flow statements.
Financial statements summarize the financial standing of a business at a point in time.
Income Tax Returns
The tax returns serve as legal, objective verification of the amounts you claim your business has earned. A potential buyer will want to see federal income tax forms that document your company’s gross sales as well as its net profit or loss. Providing at least two years of tax returns will likely be sufficient.
However, the prospective buyer may ask for three years of tax returns in some cases. One of the main reasons buyers will request an additional year for tax returns and P&L statements is because COVID may have impacted financials for 2019 and 2020.
Financial statements needed:
Profit & Loss Statement, Balance Sheet, and Cash Flow Projection
Profit & Loss Statement (P&L)
The Profit and Loss Statement will show whether or not the company has earned money during a designated time frame. For instance, a P&L Statement will show which expenditures or types of income have been most influential in this equation during a specific year.
Frequency: Quarterly and annually
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Table of Contents
Balance Sheet
The Balance Sheet provides a snapshot of your company’s financial picture at a particular moment in time, including how much you own and how much you owe.
Frequency: Typically monthly, quarterly, and annually. However, you can run a balance sheet report at any time.
Cash Flow Projection
The Cash Flow Projection lays out your company’s short-term earning potential, showing anticipated revenue as well as expected expenses.
Frequency: Typically covers a 12-month period. However, you can run these reports weekly, monthly, or semi-annually.
List of Assets
The potential buyer will be negotiating the purchase of your company’s tangible assets as well as its reputation and earning potential. Therefore, you will need to provide a detailed list of the equipment and property you will include with the sale.
Additionally, you need to document the purchase price of each item and its current value. For example, suppose you purchased a pizza oven for $2,000 with a five-year depreciation period ($400 per year). If three years have passed since the purchase, it has depreciated by $1200, and its current value would be $800.
Explanation of Adjustments
The documents you present to a potential buyer should explain the company’s financial picture that would change under new ownership. One example is you need to disclose financial arrangements with individuals or companies that won’t carry over to a new.
In addition to the financial documents, you should also have an exit planning strategy in place. An exit strategy outlines how you (the business owner) plan to sell your investment in the business. Part of a good exit strategy includes doing a business valuation assessment and a calculating valuation assessment.
Business Valuation Assessment
A business valuation assessment is an attempt to document thoroughly. It assesses the value of a group of assets: this assessment evaluates all relevant market, industry, and economic factors.
Calculation Valuation Assessment
A Calculation Valuation Assessment contains a conclusion about the value of a business’s shares, assets, or interest based on minimal review and analysis and little or no corroboration of information.
Why you should invest in an objective business assessment
A buyer will want to understand how you came up with the price. In other words, they’ll want to know your assumptions regarding growth and profitability, and will analyze your financials to see how the business has performed over the past several years.
ExitGuide is a cost-effective alternative to analysts, brokers, and attorneys. You don’t need to pay thousands of dollars for expensive professionals if you are only seeking a reasonable estimate. Above all, the business valuation could be your starting point for negotiating with a buyer. It’s helpful to clarify the buyer’s plans or intentions before setting a price.
Learn if the buyer plans to purchase and operate the business as their primary source of income or if the buyer is purchasing the business as an investment to resell.
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Getting your financials ready to share with a buyer
1. Plan your exit strategy
How you plan to sell your investment in the business is significant because you need to have some idea of how you’re going to make your exit. For example, whenever you fly on an airplane, the flight attendant demonstrates the safety features of the aircraft you are on.
A portion of this demonstration highlights the exit doors and their locations on the airplane. Usually, there are two exit doors in the front of the plane, two in the center, and two in the rear of the plane. The flight attendant points out exit doors so that passengers know exactly where to find the exits, should they need to be used.
As with an airplane, when you are selling your business, you need to clearly understand the exit strategy. Not having an exit strategy can create all kinds of havoc and chaos for you.
Solutions:
- Outline in advance how you plan to make your exit from the business
- Have a Business Valuation Report
- Have a Calculation Valuation Report
- Have a contingency plan for the sale of the business just in case
2. Organize your financials
As mentioned previously, you will need to have at least three years of clean financials when selling your business. Poor financial reporting not only hinders your ability to make informed decisions on managing or growing your company but will also destroy buyer/investor trust and confidence in your potential as an investment.
If you do not have clean financials, prospective buyers or investors cannot conduct a deep level of financial analysis. A strong buyer needs this analysis to determine if they want to move forward with the opportunity. If you cannot provide clean monthly financials, a buyer may be forced to pass on purchasing your business.
Without confidence in the accuracy of your company’s financials, an interested buyer faces risk. Therefore, they will often offer less to compensate for the risk of unclear or inaccurate financials. As buyers want to understand the costs to operate a business exclusively, running personal expenses through your business can further complicate matters. Using QuickBooks helps you to achieve clean financial reporting.
Solutions:
- Keep your financials up-to-date (monthly income statements, balance sheets, and cash flow statements)
- Do not commingle business and personal funds
- Do not commingle business and personal expenses
- Proper revenue recognition
- Review categorization of income and expenses and make corrections if necessary
- Mind your business…literally and figuratively
3. Correctly classify expenses
The integrity of the information in your accounting system is only as good as the information that you enter. That is not just a saying. It’s the truth. Your accounting process must include an expense in the appropriate account, apply the correct description or code, and enter the correct amount.
Misclassification can occur in two ways:
- Simple mistakes or
- Erroneous account assignment
A few errors to look for when reviewing accounting reports are:
- Capital assets misclassified as expenses
- Misreported start-up costs
- Expenses assigned to an incorrect business entity
- Expenses assigned to the wrong account number
- Data entry errors
Incorrect expense reporting can distort a company’s reported operating profit margins or result in over-reporting of income. Over-reporting of income would not be a good thing when selling a business. In addition, improper matching of income and expenses may cause incorrect reporting for companies using the accrual method of accounting. You or a bookkeeper can correct some accounting errors simply by making or changing an entry.
Solutions:
- Adopt best practices, following accounting industry standards
- Check for differences between the actual budget and expenses
- Train staff on correct data entry
- Do a periodic review of entries
- Have a 2-tier quality control system in place (2nd set of eyes)
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Final thoughts
Let’s face it, mistakes happen. However, if you adopt best practices, such as setting deadlines for the data entry, then reconciliation errors can be found quickly and can easily be corrected; you will be in a much better place at the end of the day. Adopting best practices, when you are ready to sell your business, your financials will be clean, as they should be. Also, properly using Quickbooks will help as well. If the prospective buyer(s) trust that the financials that you provide are accurate, you might have better negotiating leverage.
The Quickbooks Guide is a “How To” with more context as to why a prospective buyer needs these in monthly format (see trends) and what a balance sheet, AR, and AP report will tell a buyer.