A balance sheet is often referred to as a snapshot of the health of a company. Assets, liabilities and ownership equity are all shown here. The purpose of the balance sheet is to give users an idea of the company's financial position along with displaying what the company owns and owes. A simple way to look at the balance sheet is that assets equal liabilities plus owner’s equity.
When you present a balance sheet that is full of questionable items to a buyer, they will almost always question the legitimacy of your other financial statements as well. This results in a much more intense due diligence, which could even lead to a lower multiple on your business.
If the buyer does get to the point of an offer, a loosely created balance sheet will surely end with an offer that is riddled with contingencies in favor of the buyer.
Balance Sheet Red Flags
Here are potential red flags on a balance sheet that should be addressed prior to a sale:
Loans in and out of the business from shareholders
Using the company like a personal bank gives the impression of a lack of professional discipline. To this point, a business entity is created to protect you, the business owner. When personal loans are floating through the entity, an attorney could make the case that this "veil of protection" is non-existent.
Make sure that you or your CPA is properly recording fixed assets (computers, vehicles, office furniture, etc.). What you purchased these items for, as well as any accumulated depreciation, should be easy to find. We have seen cases where accumulated depreciation is higher than the actual cost of the asset. This just shows that you are not paying attention to one of the most important snapshots of your company’s health.
Footnotes are a series of explanations about the balance sheet. Here, the disclosures are made about accounting methods, valuation, excluded liabilities, and dozens of other important explanations. Make sure these tell the correct story.
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Be able to speak to volatility in year-to-year trends, complex explanations of unusual items, repetitive extraordinary items, excessive restatements of previous years and frequent changes in accounting methods.
We also see a lot of balance sheets that have dormant accounts. If you have items that appear here, and have not changed for three years, it will surely raise questions.
Devil is in the Details
The point here is that you have to take a very hard look at your balance sheet. Could you explain every single line item in detail? If not, get with your advisor and get these things cleaned up right away and show buyers that your business is operating a tight ship.
It’s not that time consuming if you devote some time every month to this exercise. Just make sure that your cash, accounts receivable, inventory and accounts payable are reconciled to the supporting bank statements and schedules. You should be able to tell your company’s "story" off of the balance sheet.