In my experience as a CPA assisting both buyers and sellers in the business acquisition process, as well as purchasing multiple companies myself, I have developed a unique perspective when it comes to a business valuation method. Here are some bookkeeping tips you can use to help ensure that when it comes time to sell your company, your financials will support the highest possible sale price.
Hire a Professional Ahead of Time
When I have looked at a business to buy in the past, I have come across many opportunities that got me excited at first blush. I would inquire on the listing and ask for financial details, but what I got back would be a terrible accounting mess. Nothing makes a potential buyer walk away from a deal faster than bad accounting. I have also helped other clients during the process of buying a business and it’s extremely hard to overcome questionable accounting.
As a business owner, put yourself in the buyer’s shoes and understand the roller coaster of emotions buyers go through – you find the business and get excited, you get more information and try to process it all, and then before (and many times after) you sign a letter of intent there are many sleepless nights and doubts. Bad accounting makes it highly likely that those doubts turn into deal killers. So my number one piece of advice is to outsource your accounting to a professional.
There are other added benefits to outsourcing your accounting as well. If you are currently doing the accounting yourself, you will now have more time to focus on increasing sales or reducing costs, which makes the business more valuable. If you have an employee doing your books, you won’t have to worry about them being done correctly, and you may be able to reduce payroll. Lastly, buyers will be more comfortable knowing there is a professional doing the accounting that can answer their financial questions instead of the owner.
Limit the “Personal” Expenses Run Through the Business
I know it’s tempting to run as many “personal” expenses through the business as possible. Every business owner wants to increase expenses to reduce taxable income if they can. However, if you plan to sell your business in the near future my advice would be to limit the personal expenses your business pays for.
While it’s not hard to prove to a potential buyer that you ran your spouse’s auto expenses through the business and those should be added back for the business valuation, the $12,000 expense from Costco that you try to add back is going to raise some eyebrows and make the buyer wonder what else is below board. Again, the prospective buyer is going to have natural doubts during the process, you don’t need to give them any additional reasons to doubt your financial statements.
Keep Your Books Current
I can’t recommend strongly enough how important it is to keep your books up-to-date. The best reason to do so is to ensure that you have accurate information to help you monitor the health of your business. If you are outsourcing your books to a professional, that person can guide you and ask why certain expenses are higher then normal or why income is down.
I see many business owners that ignore their accounting until it is time to prepare the tax return for the next year. By then, it’s too late to get any good information out of those accounting records.
- What if you have been incurring a monthly charge on your credit card for the last 12 months that is fraudulent?
- What if an employee is stealing from you all year and you just found out?
- What if you have been quoting jobs too low and cutting into your margin?
These are the types of things that happen when you wait to worry about the accounting until tax time.
Let’s contrast that with having your books done constantly. Specifically at our firm, we code transactions every two weeks and send a spreadsheet to our clients asking questions to make sure every expense is categorized correctly. We also send financials to our clients each month. So the likelihood of catching problems is infinitely greater if you stay on top of your accounting.
The other major benefit to keeping your books current is how much easier it makes selling your company. Buyers want up-to-date information before and during the acquisition process, and if you can’t provide that type of reporting it only creates more doubt in their minds.
Capitalize Equipment Purchases
Another area that business owners struggle with is when to expense purchases on the P&L or when to capitalize them on the balance sheet and depreciate them. There is no hard and fast rule for the amounts for either option, but I suggest any equipment item purchased for more than $500 should be put on the balance sheet. There are two reasons this improves your business value.
First, is the simple fact that taking the purchase off your P&L reduces your expenses, thus increasing your profit and ultimately improving the valuation. Second, the tax laws still allow you to write off the entire amount of most purchases as depreciation. This is important because accounting for this correctly will typically improve your business valuation. For example, compare these two sample ledgers:
Scenario A: Expensing Equipment for $500
- $10,000 Revenue
- $6,000 Expenses (includes $500 equipment purchase)
- $0 Depreciation ($0 because you expensed your equipment)
- $4,000 Net Profit (this is your taxable income)
- $4,000 EBITDA
Scenario B: Capitalizing Equipment for $500
- $10,000 Revenue
- $5,500 Expenses (excludes the $500 equipment purchase)
- $500 Depreciation (fully depreciate the capitalized equipment)
- $4,000 Net Profit (you have the same taxable income as above)
- $4,500 EBITDA (the depreciation gets added back in to EBITDA)
Since EBITDA is commonly used to calculate business value, you can see the potential benefit of capitalizing equipment purchase in Scenario B. And at the same time, doing this does not increase your taxable income if depreciation is done correctly.
Paying Yourself Rent
Some business owners also own the real estate where their businesses operate from. There are three different ways the real estate is typically owned – either by the same entity that owns the business, by the business owner personally or by a separate entity entirely. If it’s one of the latter two scenarios, you should definitely have the business pay rent.
I know this sounds counter-intuitive, since you are essentially taking money out of one of your pockets and putting it into the other, but this will make it easier when it comes time to sell your business, especially if you are planning to keep the real estate and charging the new owner rent for the property.
By paying yourself rent, you are showing a buyer the true picture of the business’s expenses. Otherwise, when you have a business valuation done on your company you’ll have to make an adjustment to add a rent amount back in, which will reduce profit. The net effect to the value will be the same either way, but it’s a lot easier for you to go into the valuation knowing what your profit is, rather than having to reduce it to account for rent.
Also, paying yourself rent helps support the value of your real estate if you’re planning to sell it with your business. Many commercial property appraisal techniques take income generation into account when establishing a value.
As a side note, you may also want to consult an attorney and put your real estate into a separate legal entity if you own it in the same entity as your business. Many business owners do this to limit their liability, as well as to have two distinct assets to eventually sell.
On your income statement, make sure to identify the salaries paid to owners from the total payroll amounts. This just makes it easier when it is time to sell your business, because a buyer can see what you’re earning, as opposed to having to guess or ask you to spend more time pulling reports. As far as salary amount, I recommend consulting your CPA to determine an appropriate amount, but you just have to pay yourself a “reasonable salary” as owner.
If you are paying yourself more then $75,000, you may want to think about lowering that amount and taking distributions as you are likely paying more taxes than you really need to.
Salaries for Non-Working Family Members
If you pay salaries to family members who don’t actually do any “work” for the business, you may want to consider taking them off the payroll before you sell your business. This is another area that can be confusing to a buyer when they analyze your financials.
First, they might question whether that person really had or didn’t have a role in the business that will need to be replaced and that they may be understaffed after the purchase. Second, it’s also sometimes hard to get buyers to accept these family salaries as add-backs. When buyers aren’t absolutely certain about adding back a non-necessary salary, they will leave it in their calculation, which reduces the business valuation.
By taking these family members off payroll, you prove to buyers they serve no true purpose in the business and their salaries can be added back to profit. It’s just one less thing to make buyers wonder what else is going on that doesn’t make sense or is below board in your business.
I hope the tips above shed a little light on the importance of professional bookkeeping and how it can impact the value of your business. I firmly believe that any additional cost or hassle you have to endure to bring on a professional accountant to run your books will be outweighed many times over by the increased value of your business and lessened frustration of the selling process.
Special thanks to Zach Shultz, CEO of Zenkeep, a small business bookkeeping and outsourced CFO company, for providing this article. For more about Zach or to contact him with questions, please visit https://www.zenkeep.com .