The Importance Of Financial Records

by Grover Rutter
CPA / Business Broker

Many business owners spend so much time worrying about the day to day operations of their businesses, that they never see the big picture. That may be partly because they don’t believe they have the time to “mess around” with the financial and bookkeeping aspects of their businesses. They say things like, “I have an accountant/bookkeeper that handles that.” Or, “My CPA worries about the financial end of my business — that’s why I pay him!” And here is my personal favorite, “That darn CPA firm charges me every time I ask them something. Well, I fixed them! I just don’t ask anymore!”

Business “tactics” (working the day to day business) are very important in any business operation. But business “strategy” (having an overall plan and setting goals for your business) is just as important. Making a plan for your business cannot be done without good financial records and periodic financial statements that provide important information about the business operation.

Tip: If you don’t understand certain business concepts, financial statements, or how to make a business plan, go to Dummies.com where you will find several helpful and low cost publications (no, I don’t own an interest in Dummies.com). Another reference is Decipher Financial Statements. Also check out Financial Statements — A Step-By-Step Guide to Understanding and Creating Financial Reports.

Also, have a CPA (not an unlicensed bookkeeper) prepare a financial statement for your business at least once a year. Ask the CPA to explain what the financial statement says about your business. Ask the CPA for their advice on how to improve your business. And, if you have read any of the publications I recommended, you will be better versed to understand what your CPA is telling you. Don’t be afraid to ask your CPA questions. And, if your CPA can’t answer your questions to your understanding, find a CPA that can communicate with you. You deserve to understand what is going on with your business. Doing so will pay BIG dividends in the following ways:

You will be able to make informed judgments about what may need to be done differently to improve your business,
Your business may become more credit worthy,
If you act upon what your financial statements are telling you about the business, you may be able to significantly increase your profits (thus enhancing your lifestyle), and
Consistently kept financial statements will help you sell your business when it comes time to sell the business!
Every buyer needs to see financial statements and tax returns in order to make an informed purchase. If you do not at least have annual financial statements, you have most likely decreased the value of your business because businesses with no financial history are perceived to be much riskier. Businesses with financial statements prepared by non-CPA’s are also perceived to be riskier investments. The greater the risk associated with a business — the lower the sales price of the business.

Reporting all Income
So you don’t like to pay taxes. Who does? But whatever you do, don’t cheat on your taxes by underreporting income! First of all, it is illegal. Al Capone was the notorious gangster involved in bootlegging, prostitution, organized crime and murder. But he went to prison for not reporting all of his income and paying income taxes! Okay, so you’re no Al Capone. But, you are a person who may want to sell your business some day. What do buyers look for? Income. And if buyers need to go to a bank in order to finance the purchase of your business, what do the bankers look for? Income.

I listed a small Mom and Pop tavern in a college town. “Pop” had a terminal illness and they had to sell the business. Of course, they had hoped to get what the business was really worth. The business was clean and had the greatest pizzas and subs anywhere! But the tax returns made it look like the owners lived below the poverty level! I asked the owners about the low profits on the tax returns, and they said something to the effect that anyone in the bar business will understand. That may be true. But their largest pool of buyers did not consist of people “in the bar business.” The interested buyers were folks who always “wanted” to be in the bar business. Unfortunately, once a potential buyer saw the tax returns they had great concerns about whether or not they could make a living and pay off any loans needed to buy the business. And, potential buyers who understood that the sellers were “skimming” were not able to get financing at any bank — because the bank needed to see the financials and tax returns in order to determine if the business was capable of generating enough money to repay the loan.

In the above situation, savvy buyers with cash will prey upon businesses that underreport income. They can be bought for mere pennies on the dollar. Why? Because businesses that do not show adequate income, just aren’t worth much.

Tip: Report all of your business revenue! You might think you are saving on taxes, but you are costing yourself a fortune in sales proceeds when it comes time to sell the business! There are legal ways to structure your business to take advantage of legal tax breaks that will reduce your taxes. Pay for a good tax CPA practitioner. The investment in good professional advice and services will give you very great returns when it comes time to sell your business.

Appearances
The appearance of your business has a direct impact upon the value of your business. Suppose you are in the market for a new car. You go to the dealer’s lot and sitting on the lot are two identical cars — same mileage, the exact make, model and color you had in mind. Identical in every aspect but one needs to be prepped and cleaned up. The other is spotless. Which one draws your attention? At that very moment, which auto has the greatest appeal? Some buyers might think, well, I can buy the less attractive vehicle for less money. That sentiment proves my point: Something less attractive is worth less money. Granted, a business is not an automobile. But the perception of “worth” works much the same, whether buying a car, home or business.

Tip: Keep your business establishment well groomed, inside and out. Flowers and well trimmed landscaping year in and year out goes a very long way in keeping the public’s perception that yours is a top notch business. Why is that important? You never know when some of the passers-by may become potential purchasers.

Friendly Reception
I used to own a CPA and Tax Practice. (It sold at a premium.) Our practice grew more rapidly than any other practice in our market area. We did client satisfaction surveys from time to time and these comments were frequently made by our clients:

Everyone at your office is so friendly!
We are offered coffee or soft drinks immediately upon entering your waiting room.
Your receptionists are always smiling.
Your people sound happy on the telephone!
You always make us laugh — yours is a very fun place to do taxes.
Your people are always happy to see us.”
Tip: Goodwill is that intangible asset that you can’t touch. But if goodwill exists, buyers are willing to pay for it. While goodwill is very visible in some businesses — it is totally invisible in other businesses. Want to increase the value of your business? Make every customer and visitor at your business (even people calling on the telephone) feel welcome. Set the stage so they will want to return to your business — over and over again. This will also be very obvious to any potential purchaser. Also you might remember that it is possible that some of your visitors-or customers may be future bidders on your business.

Organization
Does your company have an organization chart? Are duties of managers and employees clearly defined and documented? One of the first things a potential buyer may want to see is your company’s organization chart. I know what you might be thinking: I can do that when I get ready to sell. Well, what if you become disabled on your way to work tomorrow morning? If someone had to come in and take your business over in a short time, would they understand the chain of command?

Tip: Document your organization’s hierarchy. Not only will this help an outsider understand, it may even help your employees to better understand their place in the organization.

Operations Manual
I recently sold a home improvement company for a client. This was a very unique business, in that it was primarily a sales organization specializing in the sale of patio rooms, siding jobs, new windows and doors, etc. The company employed no installers, but rather, sold the jobs and engaged independent contractors who liked doing the installations — but hated doing the selling and administration. There were very few hard assets owned by the company, yet, we sold it for over a third of a million dollars!

One of the things that made this company so valuable was the fact that the owners had documented every function and operation in the business. Their simple operations manual had instructions on everything. Some examples included:

How to properly answer the telephone and transfer calls
How to operate the automated computerized telephone canvassing system
How to sell each type of job, and write it up
How to calculate job costs and competitively quote jobs for profit
How to order product for jobs
How to document and process independent contractors labor costs on jobs,
How to record daily, weekly and monthly financial transactions
This company sold successfully in a fairly short period of time, even though it didn’t possess a lot of hard tangible assets or tools. What made the company so profitable was the documented systematic approach to doing business. The business owner learned what worked well, and documented it! This documented system (operations manual) also made the company valuable! The buyer had a step by step guide to operating the business — which was worth a small fortune.

Tip: Develop a simple operations manual for your business, no matter the size of your business. If you have no employees, then it is up to you to prepare a simple outline of the various functions necessary to operate your business. Write it in simple and understandable terms — giving directions to someone else on “how to” perform the functions necessary to operate your business. If you don’t have employees, this will be invaluable when you hire them, because you have already detailed the job requirements. If you already have employees, get them to write up the specific functions of their jobs so that you can edit the instructions. Will this be worth your time? Absolutely! Your business may run more smoothly while you own it — and I guarantee that you will be rewarded handsomely when it comes time to sell your business!

As a business valuator and business broker I have seen the despair caused when the life’s work of business owners has little quantifiable value — because their businesses are not marketable. I have also seen the joy and satisfaction experienced by those individuals who have been able to sell their businesses for what they were really worth. It’s very uplifting work to see someone rewarded for their efforts.

In this article I have given you some very simple and basic ways you can improve and preserve the value of your business. There are many, many additional ways to build and maintain the value of your business. (Actually, I’m writing a book on the subject.) However, the ones mentioned here are those most often overlooked by a majority of business owners. Your business is what YOU make it. You have the opportunity to make it worth a lot, a little, or nothing at all.

About The Author

Grover Rutter is a CPA and Business Broker who has been dealing with closely held businesses for over 30 years. “Now that the baby boom generation is maturing, the business advice they receive has to be much different from 10 to 20 years ago,” Rutter explains.