Understanding A Profit and Loss Statement

Every deal is different, and every business has different accounting styles, but there are some standard practices. You will want to adhere to those standard practices to increase the value of your business. Easy to follow financial statements is one of the most important aspects in selling a business. The first step is actually having financial statements. You would think I didn’t have to say that, but handwritten notes, a shoe box full of receipts or verbal statements don’t work here.  

Your past 3 years of profit and loss statements are the most essential to creating a financial snapshot of your business. Just like a profit and loss statement is also called an income statement, there are different structures to this report. For our real estate services purposes, lets focus on revenue, COGS and expenses. 

Revenue:

How much money did you make due to the operations of your business? Steady percentage increase over the years is optimum.  Extreme ups or downs and/or stagnate sales show instability and that invites unfavorable purchase price terms. Of course, the more sales the better, but there are some major implications to the type of sales. Do you have a customer that is 10% or more your sales? That creates extra risk that in return lowers the value of your business. In a perfect world you have 100 customers that are each exactly 1% of your revenue.

Having your revenue as one total number is fine, there will come a time to break down sales by each service, just not necessary right now. If there are vastly different types of income then your regular business then yes, separate that out. If you have your vacation rental income on this P&L, you will want to separate that out. 

COGS:

Cost of Goods Sold. For real estate services, having underutilized COGS expenses will lower your valuation. What are the direct costs in creating the service that you sell? Including labor. You fix garage doors, the direct labor and parts to fix the door go into this category. This is incredibly important for this helps establish the scalability of your business. Product companies are valued higher then services companies because they can scale easier.  Knowing the gross profit (sale price-direct costs) of each service will show how your service line can be scaled. This is critical in attracting a buyer and their future after acquisition. A buyer pays for the past but buys for the future. 

Expenses:

If you did your COGS right these are expenses that in theory every business in real estate services should have. Of course, the costs will fluctuate by business/city, but think of the standard expenses each business has, that would go in this category. Rent, insurance, office employees and utilities are some examples. A key for business valuation is to separate out the seller/owner’s salary from your other employee’s salaries. “Compensation of Officers” is a line item on your tax returns and should be a line item on your regular P&L. You will want to delete unused line items, no need to make your P&Ls longer by having line items with no expenses tied to them. 

Getting your business accounting in order is a must to get favorable terms in your deal. Most deals die at two places, the very end or financial due diligence. What you put on your P&Ls will need to be proved by your bank statements. If not, then the trust is gone, and the deal is dead. The buyer’s first impression of your business will be your financial statements. Are you represented the way you want to be?