Balance Sheet and Selling a Business
The Balance Sheet is a critical document when selling a business. The first place almost all buyers start are the financial statements including the Balance Sheet. They typically ask first for the Profit and Loss Statements and Tax Returns as they want to see the cash flow and profitability of the business that is in the Profit and Loss Statements and then check to see if these numbers match what is on the Tax Returns.
The more sophisticated the business the greater the chances it keeps a Balance Sheet. However, many sellers don’t pay too much attention to their Balance Sheet as it is a document that requires a lot of expertise to put together. As I spend a lot of time doing business valuations, I always ask for a Balance Sheet as well as the Profit and Loss Statements and Tax Returns and if I get the Balance Sheet, can easily see whether its accurate and worth using or not adding any value.
Recently I was working with the owner of a business that they wished to sell. When I received the Balance Sheet and other financial statements to prepare the valuation, I was able to tell the seller that if they wished to sell their business for the amount in the business valuation, they would need to pay the buyer at the close of escrow about $120,000. Obviously the owner was a little stunned but here’s what was happening and it only became clear when looking at the Balance Sheet. Here are the steps that were taken to reveal the problem.
During the initial calculation of the valuation using the Profit and Loss statement it showed the business value to be about $750,000 as an asset sale. However, when looking at the Balance Sheet it showed that when the inventory, Fixed Assets including Fixtures, Furniture and Equipment and goodwill transferred to the buyer, the seller would get to keep about $113,000 in assets while around $970,000 in liabilities. That is, if the business sold for $750,000 and the seller kept the assets of $113,000 and 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 got worse as the business valuation at $750,000 was way too high. What caused the problem is the seller was showing on his Profit and Loss Statement the amounts called Other Income. For one year it was $290,000 in other income and another year it was $34,000. Both these amounts were income the seller had received as compensation for damages caused by a fire in a previous year; so they were one off payments but unrelated to the sales performance of the business. When these items were removed from the valuation it was much lower than the $750,000 leaving the seller with a large problem to manage as they were not going to get anywhere near the value for the business they were expecting.
The financial statements of a business tell a story. Each document also provides its own story – the Profit and Loss shows the performance over a period of time, the Balance Sheet shows a story at a point in time and the Tax Returns; which are signed by the seller, a summary of both of these documents.
Are you thinking about selling your business? Would you like to know the value of your business? If you would like more information please visit my website Business valuation.
For more immediate help you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.