Demonstrating profitability each year is critical to attracting potential buyers. Clean financials are a requirement for any interested party to measure and evaluate what a quality business is worth. To do this, financial records must be accurate, consistent, and timely. There are multiple types of valuation methodologies and each type relies on accrual-based financials.
To perform a valuation, valuation specialists will need to review both tax returns and financial statements to perform a calculation of value. Five-years’ worth of Clean, detailed income statements and balance sheets will be the baseline to determine an initial value. Business owners can improve the valuation by identifying “add backs,” which are expenses in the financial statements that are considered discretionary spending by an owner, or a one-time expense that will never happen again. These expenses can be added back to the bottom line of the business for the purpose of improving profitability, the company valuation, and ultimately the selling price.
Examples of “add backs” include:
- One-time operations or R&D expense (new facility build out or product launch)
- Owner’s personal car, golf club membership, boat purchase, moorage, etc.
- Salary to family members not working directly in the business
- Travel and entertainment expenses not related to the business
- Owner salaries/bonus in excess of fair market compensation
- One-time accounting or legal expense that is not related to the ongoing business
On top of clean accounting practices, asset ownership should be clear of any debt disputes and liens must be easily identified and/or transferable. The business sales price and financing of a company divestiture can be improved if property is included, so clean title is key
Hot Tip: Many small CPA firms do not have an in-house valuation specialist that has experience valuing a business specifically for the purpose of being sold on the current open-market, so be certain to work with a business broker or intermediary who performs valuations on a regular basis.