How you handle your company’s financial statements has a significant impact on how others view your business, especially when it comes time to sell. That’s why one of the first steps in our Exit Assessment process includes reviewing several years of the business’s financials.
Understanding which financial statements an owner utilizes, and how effectively they use the data, helps identify gaps - and opportunities - that have the potential to increase value in a buyer’s eyes.
Client's Financial Review Reveals Opportunities
One business owner we worked with on his exit strategy wanted to transition out of his company in 1-2 years. When we examined his financial statements, several issues came to light:
The business was only generating financial statements annually for the purposes of the tax return.
The inventory of the business escalated to 40-50% of annual sales year over year from 2020 to present.
The owner didn’t understand what was making money and what wasn’t because they only looked at their gross profit on an annual basis and didn’t evaluate by product, product grouping, or month over month.
The company was outsourcing a large portion of its manufacturing, turning the business into more of a distributor versus a manufacturer, and giving away margin.
Now this may sound like an uncommon situation, but it is not.
When a business is started, it’s all about generating sales, making sure you have cash to pay the bills and payroll, and building from there. As the business grows and matures, cash flow becomes less of an issue, and if there is cash in the bank, things are good! The problem with this approach is that the business owner often loses sight of what creates value in the business and what a potential buyer will be looking at when the owner decides to exit.
Improving Financial Management Increases Business Value
What did we learn, change, and develop that increased the value of our client’s business?
By generating monthly financial statements, we noticed significant volatility in gross profit month over month.
We learned that the business was adjusting their inventory to market based on what they were seeing the market cost to be, not what they paid for the inventory. These adjustments caused both significant understatement and overstatement of their gross profit margins monthly. We were able to adjust their internal processes to better understand the true gross profit margins, allowing for more informed business decisions.
The inventory had increased due to COVID supply shortages, and this became the normal mode of operating. They were no longer buying on true lead times to secure the inventory but rather what they had been experiencing during the pandemic. This resulted in very large inventory levels and an increased need for working capital. We were able to adjust restocking levels and reduce inventory, which increased cash flow.
There were two outsourced manufacturing operations that could be brought in-house with an immediate return on the investment. This both increased gross profit margins and reduced inventory levels, as the turnaround time from order to shipment was reduced by 2-8 weeks or more.
Potential Buyers Value Focus on Financials
What does this all mean for the business value in the eyes of potential buyers when the owner decides to sell?
Accurate and consistent financial reporting reduces the risk to the buyer.
Improved inventory management reduces the need for large levels of working capital within the business, resulting in more cash to the seller upon exit.
Providing value-add manufacturing increases the value of the business from that of a pure distributor to a value-add manufacturer and distributor.
Gross profit and net income increased due to proper costing of inventory and eliminating outsourcing of manufacturing operations.
Additional Areas to Boost Business Value
This is just one example – there are many other aspects an owner should consider to improve their business value. Some additional areas of focus include, but are not limited to:
Timing of billing and receiving of payments from customers. How early can you bill your customers? Can you prebill for work?
Vendor payments. Are you paying your bills too quickly because you have cash? Can you take advantage of discounts and/or stretch payments to term or slightly beyond?
Inventory management. When was the last time you took a physical inventory? Do you have slow moving or obsolete inventory that you can sell or scrap? Can you adjust your stocking levels to more just-in-time inventory?
Product or service profitability. Have you reviewed your products or services to determine their profit contribution? Should you cull your product line and focus both inventory dollars and sales efforts on the products that have the greatest growth opportunity and profit contribution?
Many business owners pay little attention to their accounting and financial reporting, as well as their internal processes related to managing that information. As a result, the information isn’t used to improve overall business performance, reduce financial and business risk, and increase business value upon an exit. And that equals money left on the table when you sell!
Improving your financial management today can improve your current profitability and increase the value of your business when it comes time to exit.
“Small daily improvements over time lead to stunning results” – Robin Sharma
"Financial Acumen Training brought a deeper understanding of our financials through a guided study of our own data. I now have better tools to confidently review our financial forecasting with our ownership team and identify what questions need to be asked."
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Jayne McQuillan, CPA, MBA, Certified Exit Planning Advisor (CEPA) is the owner of Journey Consulting, LLC and author of The Value Journey: How to Drive Profits, Build Wealth, and Exit Your Business on Your Own Terms.
Our firm is focused on providing business owners and their businesses with strategic planning, exit planning, financial expertise, and organizational improvement. We use a holistic approach within all of our services by aligning leadership with business strategy and outcomes.
Schedule your complimentary consultation to begin your Value Journey today!