The closing process is the final milestone in the sale of your business. After months of negotiations, due diligence, and legal preparations, this is where the transaction is completed, ownership is transferred, and you step into the next chapter of your life. While the finish line is in sight, the closing process requires careful attention […]
One of the most critical aspects of selling your business is preparing the financial statements and documentation that potential buyers will scrutinize. Organized, accurate financial records are essential for establishing credibility, building trust with buyers, and ensuring a smooth transaction. In this article, we will explore the types of financial documents you need to prepare, how to organize them, and key considerations to ensure your business is ready for due diligence.
Why Financial Preparation Matters
When selling a business, potential buyers will want to dive deep into your financial records to assess the health and profitability of your company. Properly prepared financial statements provide several key benefits:
- Credibility: Clean and accurate financials demonstrate that your business is well-managed, boosting buyer confidence.
- Value Justification: Clear financial records help substantiate your asking price by showing consistent performance and growth potential.
- Smooth Due Diligence: Proper preparation streamlines the due diligence process, reducing the risk of delays or complications that could jeopardize the deal.
Essential Financial Documents to Prepare
When preparing to sell your business, the following financial documents will be essential for buyers to evaluate:
1. Income Statements (Profit and Loss Statements)
Overview: The income statement, also known as the profit and loss (P&L) statement, summarizes your business’s revenues, costs, and expenses over a specific period. It provides insight into your business’s profitability and operational efficiency.
Preparation Tips:
- Ensure your income statements are up-to-date and cover at least the past three to five years. Many buyers will want to see these statements broken out by month to understand trends such as seasonality that an annual P&L may hide.
- Break down revenues and expenses by category (e.g., product lines, services, etc.) to give buyers a clear understanding of your business’s financial performance.
- Identify any unusual or one-time expenses and explain them in the notes to the financial statements.
2. Balance Sheets
Overview: The balance sheet provides a snapshot of your business’s financial position at a specific time. It shows the company’s assets, liabilities, and shareholders’ equity, giving buyers a clear picture of what the business owns and owes.
Preparation Tips:
- Ensure your balance sheet is accurate and up to date, with all assets and liabilities properly recorded. Similar to the income statement, some buyers will want to see this statement for each month of the year.
- Break down assets into current and long-term categories (e.g., cash, accounts receivable, property, equipment) and do the same for liabilities (e.g., short-term debts, long-term loans).
- Verify the accuracy of accounts receivable and payables, inventory levels, and any outstanding loans or debts.
3. Cash Flow Statements
Overview: The cash flow statement tracks the movement of cash in and out of your business, showing how well it generates cash to fund its operations, repay debts, and reinvest in growth. It’s crucial for buyers who want to assess the business’s liquidity and ability to sustain operations.
Preparation Tips:
- Provide a detailed breakdown of cash flows from operating, investing, and financing activities.
- Ensure the cash flow statement reconciles with your income and balance sheets. More specifically, net income at the top of the cash flow statement should tie to the income statement, and ending cash at the bottom should tie to the balance sheet.
- Highlight any significant cash flow fluctuations and provide explanations for them.
4. Tax Returns
Overview: Potential buyers will want to review your business’s tax returns for the past three to five years to verify your business’s tax compliance and assess its financial health.
Preparation Tips:
- Gather copies of federal, state, and local tax returns for at least three years.
- Ensure that all tax returns are filed on time and that no outstanding liabilities exist.
- If there are any tax disputes or pending audits, be prepared to explain them to buyers.
- In general, it is best to have tax returns available for each legal entity in your company’s operating structure.
5. Accounts Receivable and Payable Aging Reports
Overview: Accounts receivable (AR) and accounts payable (AP) aging reports provide a detailed look at the money owed to and by your business. Buyers use these reports to assess the efficiency of your credit management and the likelihood of collecting outstanding debts.
Preparation Tips:
- Prepare aging reports that show the status of all receivables and payables, broken down by the number of days overdue (e.g., 30, 60, 90 days).
- Highlight any overdue or potentially uncollectible accounts and provide explanations.
- Ensure that payables are up-to-date and that no significant outstanding liabilities exist.
6. Debt Schedules
Overview: A debt schedule lists all outstanding debts and liabilities, including loans, credit lines, and other financial obligations. Buyers need to understand a business’s debt load to assess its financial risk and ability to service its debts.
Preparation Tips:
- Provide a complete schedule of all outstanding debts, including interest rates, maturity dates, and repayment terms.
- Document any collateral or security tied to the debt.
- Be transparent about any upcoming balloon payments or significant financial obligations.
- Highlight debt items that can be considered due to or from a related party – i.e., shareholder notes, notes to/from sister companies, or notes to/from parent companies/subsidiaries.
7. Inventory Reports
Overview: If your business holds inventory, potential buyers will want to review your inventory reports to assess its value, turnover rate, and overall management efficiency.
Preparation Tips:
- Provide a detailed inventory report, including quantities, values, and inventory aging.
- Verify the accuracy of inventory counts and valuations, especially for raw materials, work-in-progress, and finished goods.
- Address any issues with obsolete or slow-moving inventory and provide solutions for managing them.
8. Employee and Payroll Records
Overview: Employee and payroll records are important for buyers to assess your business’s workforce and understand labor costs, including wages, benefits, and bonuses.
Preparation Tips:
- Prepare a summary of current employees, including their roles and compensation.
- Provide payroll records for the past year, including details of benefits, bonuses, and commissions.
- Be prepared to disclose employment contracts, non-compete agreements, and potential labor issues.
Organizing and Presenting Your Financial Documents
Once your financial documents are prepared, it’s essential to organize them in a way that is accessible and easy to review for potential buyers. Here’s how to do it:
- Create a Digital Data Room: A secure digital data room allows you to store and share financial documents with potential buyers during due diligence. Ensure that the data room is well-organized with clearly labeled folders and documents.
- Be Transparent: Buyers will appreciate transparency. Provide clear explanations for any irregularities or unusual items in your financial statements. Address any known issues upfront to avoid surprises during due diligence.
- Work with Your Advisors: Collaborate with your accountant, attorney, and M&A advisor to ensure that all financial documents are accurate, up-to-date, and compliant with relevant regulations. Their expertise will help you present your business in the best possible light.
Conclusion
Preparing your financial statements and documents is crucial in selling your business. Ensuring that your financials are accurate, well-organized, and transparent can build trust with potential buyers, streamline the due diligence process, and maximize your business’s value.
Next Steps
- Explore the Western Perspective page for more articles like this.
- Explore the Western Testimonials page for stories of business owners Western has worked with.
- For more information on how to explore selling your company, visit https://western-companies.com/sell-side-ma/ or contact Western’s Chief Commercial Officer Rick Groesch at rick@western-companies.com.
Additional Reading
- Initial Steps in Preparing to Sell Your Business
- Why Should I Hire An M&A Advisor
- Understanding Business Valuation