The Importance of Financial Statements
Selling a real estate service business is not easy, but one of the surefire ways to predicting success is having clear, clean, and concise financial records. Ideally, we have spoken years before you plan on selling, this way you have the time to make your financials easy to follow for buyers. This is the equivalent of fixing your roof or painting your house before selling. Take this into consideration, a buyer will look at your financials before meeting you, what type of first impression do you want to present?
Profit and Loss Statements or Income Statements:
This is the most critical statement needed to present your business. P&Ls or sometimes called Income Statements is the financial lifeblood of your business. And just how there are different names for these documents, there are different ways to create them.
Showing at least 3 years, preferably 5 years of ups, downs, and profits. Revenue at the top and expenses below to show the bottom-line number. I think an underrated P&L trick is not showing the many different revenue streams, for most P&Ls just have one top line number. You have multiple revenue activities, break them down to show the buyer where the money is coming from. Buyers will also want to see the revenue percentage growth year over year.
The COGS section is the most underutilized section on P&Ls. Sometimes there isn’t even a COGS section. In real estate service businesses, your materials AND labor that is needed to produce your service should be in this section. All employees in the field go into this section, while all employees in the office go to operating expenses. The easier the buyer can see where the money is going the more comfortable they will be in understanding your business. Do your COGS accurately show gross profit or is everything lumped into operating expenses?
Operating expenses are an alphabetical list of expenses. A good way to think about this section is a list of expenses that all businesses have. Rent, utilities, marketing, software, bank charges, etc. The list goes on and on, but the important here is to pull out and find the owner write-offs that the next buyer will enjoy. Where is your health and car insurance cost or is it put together with on one line with all your employees? The biggest one is owner salary. There is a line item on IRS forms “Officer Salary”, this will be one of your biggest add-backs, separate it out so the buyer can see that easily.
We all know that businesses are valued off a multiple of SDE. Can the SDE be easily proven by looking at your P&Ls? We don’t live in a perfect world, so any qualified buyer will not expect perfect P&L statements, but they will need to know the story that goes with the numbers.
Balance Sheets
In the investment banking world balance sheets are more important, but for our sakes they are still very valuable. Assets on the top, the biggest question will be your accounts receivable. If this is larger (over 20% of sales) then a buyer will know cash flow is a problem. The AR line item is the most important line item on the balance sheet. Real estate services will have a healthy AR, so the next question is how often does it turnover? Net 30 is the standard terms, but do you collect a deposit? If so, your AR will be lower and should turnover faster. Easier said than done, I get it, for some customers (Government), do not pay deposits. Cash accounts are commonly over-exaggerated by inexperienced buyers, if they don’t understand that cash at any given day can be different, then we don’t want to work with them. A year-end balance is nice to see over many years, but AR will be our focus in the assets section.
For the liabilities and equity section is not that critical for we are always trying to sell a business free and clear. That is not always the case, but these sections in theory should reset with the new owner. Any loan on the business will be shown here and be prepared for why you have a loan in general. Your distributions will be shown here and should have totaled properly over the years, another good time to show look how much money I have taken out in cash over the years.
As critical it is to have financial statements prepared for potential buyers, having them updated during due diligence is just as important. Nothing will scare a buyer more than delayed, up-to-date P&Ls. They will start to second guess the business and the management team they will be inheriting.
This is where I will always want to show the previous year’s monthly P&L statement. We all know there are ups and downs in every business, especially in certain months. Buyers sign an LOI in June. Get the June financials in July, do a quick equation to predict yearly revenue, then freak out for most of the time summer months are slow. That is why I like to have the previous June to show an apples-to-apples comparison.
Your financial records are the money story of your business. Don’t forget this is an investment for the buyer. What does your story tell?