Value Drivers: Developing Financial Controls to Manage Your Business


 As we have discussed in the past few articles, getting a premium price for the sale of your business can depend, in large part, upon your efforts to adopt and implement value drivers. The last value driver that we are going to discuss in this series of articles is the existence of reliable financial controls that you can use to manage the business. Documented financial controls are not only a critical element of business management, but they also can help safeguard a company's assets. Most importantly, however, effective financial controls help verify (for the buyer) the financial condition of your company.

During the sale process, the buyer will likely conduct an extraordinarily detailed examination of your company’s finances known as financial due diligence. If the buyer's auditors are not completely comfortable when reviewing your company's past financial performance, the buyer will probably walk away from the deal (or, at best, give a lowball offer).

Take for instance a scenario in which a business owner tells a potential buyer that the company has been making $5 million per year for the past three years and expects it to make even more in the future. Are you really surprised that the buyer’s first thought is, "Prove it!" If a seller then produces financial information that proves incorrect, insupportable or incomplete, the buyer will be highly skeptical or, more likely, simply gone. You would never pay millions of dollars without complete confidence in the company’s financial information. Should your buyer?

One of the best ways to document that the company (1) has effective financial controls and (2) its historical financial statements are correct is through a certified audit by an established CPA firm. A certified audit is important because lack of financial integrity has been observed as one of the most common hurdles encountered during the exit process. An audit demonstrates to potential buyers that the historical information can be relied upon when making judgments about buying the company based on historical cash flows. It can be very important to have your CPA review your current financial statements and practices so that any financial irregularities or inadequacies are immediately exposed and corrected.

One common "irregularity" that we often see in companies is the shifting income. Everyone, buyer included, understands that for the years prior to the sale, owners will naturally handle the company's finances from a perspective of minimizing tax consequences. This is good tax planning and is anticipated by the sophisticated buyer— the kind with whom you are likely to deal.

Unfortunately, some owners go one step too far in an effort to minimize tax consequences. They shift income from one year to the next and shift expenses fromone year to the next—neither the expense nor income shifts relating to each other, or to the actual services or manufacturing activities that give rise to the income or expense item. Other owners may improperly report inventory or lack sufficient inventory controls. For an example of this financial irregularity, let’s look at the story of fictional owner Vince Diamond.

Vince Diamond owned a successful plumbing parts company in Detroit, Michigan. For years, Vince had understated his inventory in an effort to reduce his profits, thus reducing his tax liability. Vince provided the doctored numbers to his accountant who year after year, used those numbers to prepare the company’s tax returns.

At Vince’s 60th birthday party, his youngest son (who Vince had always hoped would take over the business) announced his plans to attend medical school. Vince’s employees had neither the money nor the will to take over the company so Vince decided to investigate the option of selling his company.

During Vince’s first meeting with a business broker, the broker questioned Vince’s stated inventory of $250,000. "How can you possibly support annual sales of $2.5 million with an inventory this small? Vince then admitted how, unbeknownst to his accountant, he had cleverly "saved hundreds of thousands" in taxes over the years by understating his inventory.

"Well," his broker began, "now you face a difficult choice. We can correct your inventory numbers so that your EBITDA will support a $10 million sale price." "Great! Let’s do it!" Vince replied. "If we do," the broker cautioned, "the IRS can, and probably will, charge you with tax fraud."

Vince then asked, "What happens if we let the numbers stand?" The broker replied, "In that case, I have good news and bad news. The good news is: you don’t go to jail." Taken aback, Vince asked, "Then what is the bad news?" The broker replied, "The bad news is that without correcting the numbers, your company’s EBITDA is too low to support a $10 million price. In fact, no buyer will want to risk buying a company with unsupportable numbers."

Dejected, Vince left the broker’s office. He ran the company for eight more years until he had enough money in the bank to support himself in his retirement. At the end of those eight years, Vince liquidated what he could and closed the doors.

If you recognize yourself as an owner who has been overly aggressive in shifting income and expenses, (or, more likely, have given the financial controls insufficient attention over the years) it is of fundamental importance to the entire sale process that your past aggressiveness be diligently reviewed and corrected where appropriate. Making sure that you have effective and documented financial controls within your business can be the value driver that makes or breaks the sale of your company.

As we have discussed in this series of Exit Planning Navigator® value driver articles, concentrating on developing and enhancing your company’s value drivers can position you to get a premium price for your business.
nav bottom header 
Subsequent issues of Exit Planning Navigator® discuss all aspects of Exit Planning. If you have any questions regarding the Exit Planning process, please contact Kevin Short, Managing Director (