Clear Financials Don’t Raise Your Business Value — They Prove It

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Transcript:

Someday, each of us is going to be leaving our business. When that happens, I want to make sure that when we sell it, we get the most for it. Stay tuned and I'll show you how to present your financials in a way that shows the premium that should be paid for the business.

Well, hello there. Welcome to another edition of your money in your business. I'm Jonathan Ankney, the Small Business CFO.

As I said, we're going to be leaving our business someday.

And if you're like me, you have an immediate reaction, which is something like this. It's my baby. I don't want anyone else touching it. Or I'm never really going to fully retire. I just want to continue to manage the business.

But I have to say to myself and I say to you if that's the case, get over it. Not in a cruel way, but the reality is that someday I will no longer be in my business.

I'll retire, go on disability, or possibly even death when that time comes. It's the same for all of us. So we need to be prepared now so that when it happens, you or your loved ones get the most for it.

The problem that I have seen are business owners where they report their personal payroll expense, their personal wages, their personal expenses, things that are still related to the business or that their benefits, but they go to them, that they report them as part of their general overhead. They're folded into the business's overhead. And when it comes time to present the financials to potential sellers, it's not clear how much of that money actually went to the owner and how much is a core business expense that that seller is going to have to pay.

So let me show you on the screen. I have a sample P&L from QuickBooks. It's actually a terribly designed one, but let me show you what it looks like here.

When we come down here and scroll through here, let's start with payroll up here.

When we look at payroll, we have $245,000, we've got automobile expenses of $15,000.There's nothing in here as I scroll through that suggests that there are owner's expenses.

There will be in a moment, but right now there's not.

So it's showing that the net income is $34,500.  Now, when we redesign this report, it's just a matter of some simple configurations. When we redesign it, what happens going back up here to payroll expenses for example, I will highlight this and I will highlight… where is it? Oh, it's an automobile.

When we go down here to the bottom, we see that we have moved the owner's compensation down below and we have moved a portion of the automobile expenses below. Why is that? That is because these are the owner's expenses that they are taking out of the business.

And if they sell their business, not if, when they sell their business to another owner, suddenly that that owner is not going to be adopting the current owner's payroll costs.

They're not going to be adopting the owner's auto lease costs because they have their own compensation.

They have their own auto lease.

Notice that net income is the same in both of these situations.

This is what the IRS is going to take a look at. This is what the taxes are based on. These are not what the selling price is going to be based on. The selling price is going to be based on these numbers up here. Now, I went online to take a look and see what a typical multiplier was for landscaping businesses.

In the website that I found, it's a small M&A firm, said that the multiplier is typically two to four times what this number is. So let's just take a look and see what the difference is.

In this scenario, the multiplier is the low end of the selling price is $70,000. On the high end, it's $139,000, we'll call it a $140,000.

When we take out these expenses and move them below the net ordinary income, now we have a 2X multiplier of $392,000 all the way up to $783,000.  Obviously, I've rounded here but you see the picture. You see the significance.

The significant increase in the value of the business because the owner's compensation was taken out and moved below operating expenses, isolating the normal profit and the normal expenses to give us what a normal ordinary net income looks like.

A huge, huge difference.

So I want to actually go for a moment to a story because I was talking to a business owner the other day who said that he was speaking to multiple businesses about acquisitions. And he said that the reason he walked away from the deals was because they could not demonstrate easily what the owner's portion of the expenses were and therefore he could not make a good decision on whether or not this was a good business to buy. And I will mention by the way that doing it this way, thinking about it now and having clarity about it now also signals to potential buyers that your books are in order.

You have them set up already anticipating what's going to happen and that you've already thoughtfully gone through the expenses and allocated out what were the expenses that I took out of the business and what's going to be left over for the potential owner? It's well organized. And it's not just about compensation either. It's about discretionary expenses. So you could have things like your club dues, obviously, your own benefits, charitable contributions, probably if you're in a pro professional development program.

You don't know whether or not the new owner is in a professional development program or not, and it doesn't matter because this was a program that you were in, not them.

So my goal here is to think strategically about how to get the most reward for your work and then how to structure your financial reports, your p and l especially, so that the value of the business, the net operating income pops out. And of course, if you're not sure about how to go about doing this, if you need to get a second opinion around your books and how they're done, go ahead drop me a line and we'll talk.

Until next time, I will see you in the next video.

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