Preparing Financial Statements When Selling a Business

Jacob Orosz Portrait
by Jacob Orosz (President of Morgan & Westfield)

Executive Summary

To enhance the value of your company, you must position it in the best light. Clearly organized and reconstructed financial statements can maximize the value of your business in the eyes of potential buyers.

In our decades of experience, these are the most frequently asked questions we hear regarding financial statements and some tips for addressing them:

  • What kind of financial information do buyers ask for?
  • Which financial statements should I show a buyer before they make an offer?
  • What backup documents should I prepare in addition to financial statements?
  • Should I give buyers raw financial data or adjusted financial statements?
  • When should I supply year-to-date financial statements to a buyer?
  • What if I have a cash business with inaccurate financials?

What Kind of Financial Information Do Buyers Ask For?

Buyers typically ask for the following:

  • Three to five years of profit & loss (P&L) statements
  • Balance sheets
  • Bank statements
  • Federal income tax returns
  • YTD comparison P&L statement.

Before the offer. It is appropriate to show a buyer a P&L statement before an offer is made. In some cases, it might also be appropriate to share a balance sheet with a potential buyer.

After the offer. Source documents such as federal income tax returns and bank statements are normally shown only after an offer is accepted. Most buyers will ask to see bank statements in addition to financial statements, and these bank statements should match the financial statements as closely as possible.

Most buyers hire a CPA or accountant to help them perform financial due diligence. The accountant will evaluate all financial documents and reconcile the numbers between your financial statements and your bank statements, invoices, receipts, and tax returns to ensure they match.

Organize your financial records. Owners who are serious about selling should organize the business’s financial records for the previous three years, broken down in an easy-to-navigate format that can display the data by month. Whether offline documents are gathered into a physical, labeled folder system or digital documents are organized into folders on your computer, you can prepare for the inevitable time when your buyer will want to review all the paperwork.

If you would like to learn more, listen to an M&A Talk Podcast I recorded with Helena Robbins on preparing for financial due diligence.

Should I Give Buyers Raw Financial Data or Adjusted Financial Statements?

Never give potential buyers raw financial data without a list of adjustments.

Giving buyers your raw financial data leaves a lot of room for misinterpretation and confusion. When you give buyers “just the numbers,” you are trusting that they will understand how all the pieces fit together in the overall system. However, they will not be familiar with the intricacies of your business and won’t be aware of the adjustments that should be made to your financial statements.

Reconstruct all financial statements to accurately reflect the true profit of your business. Most business owners write off personal business expenses, such as their phone and utilities, travel expenses, auto expenses, and maintenance, personal products, and other expenses for which they qualify.

In theory, the process of adjusting financial statements to reflect accurate expenses and income — also known as “recasting” or “normalizing” your financial statements — is simple. However, the buyer must be familiar with your business to know which adjustments to make.

Start with your P&L statement, and format it in a four-column spreadsheet, separated into “Original” financial statement numbers, “Adjustments,” and “Normalized” numbers, with the fourth column for “Notes” or “Explanations.” This should suffice for most buyers’ needs.

When Should I Supply YTD Financial Statements to a Buyer?

Provide gross sales for the current year in preliminary stages. When a buyer requests a YTD financial statement, we suggest that you provide them with the gross sales figures only for the current year.

Provide a YTD comparison P&L with adjustments during negotiations. You can provide adjustments for your year-to-date financial statement when you are in negotiations with a serious buyer. Otherwise, you would have to adjust your financial statement every time you update your financial data for the current year. Providing buyers with gross sales numbers for the current year should be sufficient.

We recommend providing buyers with a year-to-year comparison. This allows the buyer to see how your business is performing relative to prior years. It also allows the buyer to create a projection for the current year. (This assumes that your expense structure has not dramatically changed.) For example, if it is currently September, provide the buyer with the gross sales for January – August of the previous year and January – August of the current year.

What if I Have a Cash Business with Inaccurate Financials?

Businesses that conduct a lot of cash transactions are becoming less common. From retail to professional services, cash-based businesses face a number of challenges in accurately reporting the variables associated with the easy-moving, “liquid” nature of cash-heavy businesses.

If you are selling a business with a heavy cash component, we recommend the following:

  • Give potential buyers verbal information only, clearly explaining that they will have the opportunity to confirm and verify the information with your records after an offer is accepted.
  • Offer potential buyers an observation period during which they can observe the business and determine the cash flow.
  • Offer buyers a projection/pro-forma financial statement with extreme caution. The bottom of every page of the projection document should clearly state that the information is an estimate, and buyers should not base decisions to buy on the projection. You should depict the business’s situation as accurately as possible. However, if you clearly mark the document as a “projection,” you limit your liability.