Getting your books in order

The short version

• Buyers and their lenders need to read your numbers, check them and trust them.
• Start with three to five years of financial statements that tie to your tax returns.
• Separate personal and business spending, and document anything that still mixes.
• Lenders check your tax returns directly with the IRS. Income you did not report cannot count toward your price.
• Start early. Cleaning up the books takes months, and clean history cannot be created after the fact.

What buyers and lenders need to see

A buyer's accountant and the buyer's lender will go through your records line by line. They want four things:

• Financial statements for the last three to five years, plus the current year to date.
• Tax returns for the same years.
• Statements that tie to the returns. The numbers match, or each difference is explained in writing.
• Monthly detail, so they can see seasons, trends and anything unusual.

Accrual, not only cash

Many small businesses keep their books on a cash basis. That records income when money arrives and expenses when they are paid.

Buyers and lenders read accrual books more easily. Accrual records income when it is earned and expenses when they are owed. It shows what the business really did in a month, not just when checks cleared.

Your accountant can prepare accrual statements from cash books. Ask them to do it for every year a buyer will see.

Three levels of outside work

An outside CPA can prepare your statements in three ways. Each costs more and gives a buyer more confidence.

• A compilation. The CPA puts your numbers into proper statements but does not check them.
• A review. The CPA asks questions and runs checks, and gives limited assurance that nothing obvious is wrong.
• An audit. The CPA tests the records in detail and gives an opinion. Audits are rare for small businesses.

Most small business sales happen with compiled or internally prepared statements. A review can help if your business is larger or your records have been informal.

Separate personal and business spending

Many owners run some personal costs through the business. Buyers expect some of it. What they need is a clear record of each item, so it can be added back to earnings. Lesson 5.3 covers add-backs.

Going forward, keep personal spending out of the business wherever you can. Every clean year makes the next conversation easier.

Unreported income does not count

Lenders confirm your tax returns directly with the IRS. If income was never reported, it cannot be counted toward what the business earns. It cannot be added back, and it cannot raise the price.

Other records to put in order

• Bank accounts reconciled every month.
• Reports of who owes you and who you owe, and for how long.
• A list of every business debt.
• Inventory counts and values, if you carry inventory.
• A list of equipment and vehicles.

These go into your data room. Lesson 2.6 covers what goes in it, and Lesson 5.2 covers how to gather it.