The Balance Sheet is a critical document when selling a business.
The first place almost all buyers start is with the financial statements, including the Balance Sheet. They typically request the Profit and Loss Statements and Tax Returns first, as they want to assess the business’s cash flow and profitability, as these financial statements demonstrate. Then, they check to see if these numbers match what the Tax Returns show.
The more sophisticated the business, the greater the chances it keeps a Balance Sheet. However, many sellers don’t pay close attention to their Balance Sheet, as it is a document that requires a lot of expertise to compile. As I spend a lot of time conducting business valuations, I always request a Balance Sheet, as well as the Profit and Loss Statements and tax returns. If I receive the Balance Sheet, I can easily determine whether it’s accurate and whether it adds value.
Recently, I was working with the owner of a business that was ready to sell. After receiving the Balance Sheet and other financial statements to prepare the valuation, I was able to inform the seller that if they were ready to sell their business for the amount in the business valuation, they would need to pay the buyer approximately $120,000 at the close of escrow. Obviously, the owner was a little stunned, but here’s what was happening, and it only became clear when looking at the Balance Sheet.
It’s all in the math.
During the initial calculation of the valuation using the Profit and Loss statement, the business valuation came in at approximately $750,000 as an asset sale. However, when examining the Balance Sheet, it was revealed that when the inventory, Fixed Assets (including Fixtures, Furniture, and Equipment), and goodwill were transferred to the buyer, the seller would retain approximately $113,000 in assets, while incurring around $970,000 in liabilities. That is, if the business sold for $750,000 and the seller retained the assets of $113,000, then paid out the liabilities of $970,000, he would be at least $107,000 in debt.
If the above was not bad enough, it became worse as the business valuation of $750,000 was significantly too high. The problem arose because the seller was showing on his Profit and Loss Statement the amounts labeled as Other Income. For one year, the amount was $290,000 in other income, and for another year, it was $34,000. Both of these amounts were income that came to the seller as compensation for damages from a fire in a previous year; therefore, they were one-off payments unrelated to the business’s sales performance. When these items were removed from the valuation, the amount was significantly lower than the $750,000, leaving the seller with a substantial problem to manage, as they were unlikely to receive anywhere near the value for the business they were expecting.
Financial statements share a story.
The financial statements of a business tell a story. Each document also provides its own story – the Profit and Loss statement shows performance over a specific period, the Balance Sheet shows a snapshot at a point in time, and the Tax Returns, which the seller signs, is a summary of both of these documents.
Are you thinking about selling your business? Would you like to know the value of your business? For more information, please visit my website, Business Valuation.
For more immediate assistance, you are welcome to send an email to Andrew Rogerson or call me at 916 570-2674.