Financial reporting is complicated and can be a mystery wrapped in a riddle – inside an enigma. What do potential buyers look for and more importantly, what financial reporting metrics create the highest multiple of cash flow of which buyers will pay a premium?
If a business owner sends us a set of financial documents and you say, “this is perfect. This is exactly what business accounting looks like.” What would be included in that set?
We visit with S&P Capital Partners’ Frank Muraca, to understand what most businesses miss in accounting and what improvements will generate a higher cash flow multiple.
A perfect set of books and records includes accrual-based accounting statements with a good month-end closing process to ensure expenses match revenues. Period. It’s not uncommon for owners to have minimal accounting experience, but a lack of accounting experience & expertise in the back office can create challenges when evaluating financial results. Most owners develop key “gut” metrics over time which work around poor and/or incomplete books and records, but when a potential buyer starts to do their due diligence the missing support data creates lender financing challenges. Business owners commonly have a level of cash or AR that “tells” them things are good based on their years of working with incomplete statements. Clean, timely closed books and records make communication with potential buyers much easier.
What do you commonly see in valuations that are problematic? What do businesses generally not record properly?
A lot of business owners record cash sales and then do not report the income. Everyone at some point and some level does it. However, sometimes these amounts can be significant. The tax savings on these lost sales, however, are insignificant in relation to the value of those sales in the overall enterprise value of the business when it comes time to contemplate a sale.
If you could ask businesses to stop doing one thing?
Comingle personal expenses with business expenses so badly that personal cannot be differentiated from the business. Just about every business owner has some personal expenses running through their business, however, if these cannot be easily identified then just like unrecorded cash sales the minor tax savings on putting these expenses through the business is a fraction of the benefit of keeping them out when a valuation looks at a multiple of cash flow. As an example, running $10k of business expense will save about $3-4k in taxes but will cost $40-70k in enterprise value at the time of sale.
What should an owner/management team know in real-time? What critical metrics should an owner review regularly and know off the top of their mind?
Days Sales Outstanding is a good one, that helps the owner understand how quickly they collect on sales (not a good metric if they are cash basis statements but accrual is the way to go) for leveraged business the Cash Flow to Debt Ratio would be good to ensure liquidity. A good understanding of their gross and net margins per sales dollar is always good to know. Finally understanding the company’s Working Capital Ratio is always good, allowing owners to know their liquidity and economic health.
Who should be in charge of CFO duties at different revenue levels? (skill sets/resume experience should they have)
- $10m Should have a good accounting manager or Controller, may need a bookkeeper as well.
- $20m Possibly a CFO, definitely a Controller and adequate staffing
- $40m + CFO, Controller, adequate staff which may include inventory specialist, AR and AP manager…
If a seller is 2-3 years or more out, what should they know that they probably don’t about financial reporting?
Stop running personal expenses through the business or set up ONE credit card for such transactions if necessary. Get all sales on the books. Set up a clean month-end closing process and review the statements every month with the respective team. Look to set up good KPIs to help drive the business and get buy-in from the org chart on targets.
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