Recast Financial Statements

April 13, 2006

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One thing that virtually all small business owners do to "dress up" their business before a sale is to recast historical financial statements for the last three to five years, and draw up projected statements that reflect how the business would look with a new owner.

If you're like most small business owners, you've operated your business in a way that's calculated to minimize taxes. You may have given yourself and family members as many perks and benefits as possible, kept your children on the payroll, plowed a lot of profits back into capital improvements, etc. These and other tactics are designed to keep your profits (and your taxes) low, perhaps artificially so.

Now, however, you want to make your company look as profitable as possible. Ideally, you would take steps to improve your actual earnings for several years before putting the company on the block. If time does not permit (or in addition to) this step, you can have your accountant adjust your past income statements to reflect what would have happened if you:

removed your salary and perks, and those of family members you don't expect to remain with the company
removed any expenses or income that would not be expected to recur or continue after the sale (for example, income or expenses associated with discontinued products, or gains or losses from the sale of any business assets)
removed any investment or other nonoperating expenses or income
removed interest payments on any business loans, since you'll be removing such liabilities from the balance sheet.

Furthermore, your accountant can adjust your past balance sheets to:

Remove any assets that will not be sold with the company.
Remove any obsolete or slow-moving inventory. Value the remaining inventory at current replacement cost.
Value your remaining balance-sheet assets at current fair market value.
Write off any accounts receivable that are uncollectable.
Write off any loans the company made to you.
Remove other debt that will not be assumed by the buyer.

Your accountant may have some other ideas; for example, you may have expensed some costs that could have been capitalized.

Whatever you do in the way of recasting your financials, make sure that any changes to your historical statements are carefully documented on the face of the statements, so that the buyer knows you aren't trying to cover anything up.

Finally, you should have your accountant take these recast financials and use them to project how your future statements are likely to look for the next five years, making reasonable assumptions about future growth or decline in income, expenses, value of assets etc. In most cases, that means assuming that trends established over the past several years will continue; for example, if revenues have increased by 5 percent a year, it's probably reasonable to assume that growth will continue at that rate.