Do your financial statements truly represent the performance of your business?
“Of course they do,” you might say. “I’m honest and record everything.”
When dealing with tax and regulations, that’s a wise strategy. But when selling your business, including everything in your financial statements may not reflect your company’s true earnings potential (usually calculated as Seller’s Discretionary Earnings).
Are personal or one-off purchases, for example, legitimate business expenses? Would they recur under new ownership, and if not, how should you adjust for them?
You answer these questions with a financial recast.
To help maximize your exit, your M&A advisor will work with our finance team to separate true business expenses from incidental, personal, or other non-business expenses and adjust accordingly. Otherwise, once buyers feed your financials into their valuation models, you could leave money on the table.
The bigger the numbers going into these models, the better your valuation in many cases. Recasting your financials, therefore, can help justify or increase your asking price and may result in better offers that reflect your company’s true worth.
Let’s explore why recasting your financial statements leads to a truer indication of future performance, how financial recasts work, and who can help you prepare them (hint: we can).
What Is a Financial Recast?
A financial recast restructures your financial statements to give buyers a more relevant picture of your business performance, a clearer indication of how it’ll perform when it changes hands.
Your financials likely include every credit and debit in a standard format that tax agencies like the IRS like to see. Although this makes your accountant’s job easier come tax season, when it’s time to sell your business, it can create a false impression of your company’s performance.
Perfectly legitimate travel expenses like conferences or company automobiles reduce company tax liability, but probably won’t be the same with the new owner at the helm. This “discretionary” spending will be theirs to allocate to other projects, growth, or take as income.
Likewise, do you draw a salary? A potential acquirer wants to understand your business’s true earnings potential. They might not take a salary or structure compensation differently, so including a six or seven-figure salary in the expenses column eats into your EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), penalizing company performance.
Recasting financial statements reveals this by adding back in your salary, benefits, one-off, and non-essential expenses to EBITDA so buyers understand your business’s cash flow and earnings potential.
Why Recast Your Financials?
Attracts Buyers
Recast financials shift the conversation from profit to discretionary earnings, which is often higher, appealing to more buyers. Equally, a financial recast allows buyers to compare how your business fares against others. Without your personal impact on the books muddying the waters, your business better catches the eye of the right buyers.
Creates Goodwill
Savvy buyers will recast your financials. Save them time and effort by recasting your financials before entering acquisition talks, and you’ll foster stronger relationships. Showing your motivation to sell and being transparent about your financial data also creates goodwill you may later rely on when negotiating. From the buyer’s perspective, anything you do to make their job easier is a plus, leading to warmer conversations.
Accelerates Due Diligence
By recasting your financials before you sell, not only do you save time doing it later during due diligence, but you’re also likely to spot inconsistencies or errors in your reporting. Explicitly describing how you got from your accounting system to SDE builds credibility, and due diligence goes much faster when there are no adjustments or surprises. Plus, you don’t want to risk buyers renegotiating your deal.
How to Recast Financial Statements
Financial recasting essentially involves calculating a financial metric called Seller’s Discretionary Earnings (SDE). Here’s the formula we use at Acquire.com:
SDE = EBITDA + Your Salary + Your Benefits + One-time Expenses + Non-essential Expenses
The Financial Recasting Process
- Data Gathering – First, we ask you to submit a profit and loss (P&L) statement, balance sheet, and cash flow statements. Each statement should cover the entire period of the last three years and year to date on a single sheet, broken down by month for the entire period. For easy comparison and consolidation, always use consistently formatted documents.
- Summarization – Next, we consolidate the P&L data, highlighting gross revenue, expenses, and EBITDA. To give a snapshot of your financials, we also summarize the trailing twelve-month data.
- Adjustments – Expenses like your salary, personal travel, and other perks are adjusted to reflect the company’s true earnings potential. We also remove any large financing expenses, like loan interest, that won’t transfer to a buyer.
- Review – Before sharing the recast financial documents with buyers, we review them a final time to ensure accuracy (of the recast, not the underlying accounts) and completeness.
- Presentation – Finally, we prepare the recast using a standardized template, allowing buyers to compare it the financial performance with other businesses more consistently.
To understand the impact of a financial recast, see this example where adjusting for the founder’s $250k salary quadrupled the company’s financial valuation. Without a recast, this founder might not have sold or done so at a price that the company deserved.
Who Does a Financial Recast?
Usually an accountant, M&A advisor, or business broker recasts your financials. Don’t do it yourself unless you’re confident in your ability. It’s not a complex calculation, but qualified accountants may spot errors you won’t. And for the recast to be effective, the data must be accurate and reliable, and buyers may give more weight and credibility to a qualified third party’s adjustments than your own.
When selling your business on Acquire.com, your M&A advisor will refer you to our financial department for a financial recast. We offer this service free to help you sell for the best price possible, ensuring your financial statements offer a true indication of future performance while being in a consistent format that buyers like to see (making their jobs a little easier as a result).
Speak to your M&A advisor to see if a financial recast is right for your business, or sign up for a free seller account now and request help through our support team.
How Long Does Financial Recasting Take?
Depending on the business, a recasting financial statements can take as few as 30-45 minutes. Clean accounting records are easier to recast, and some accountancy software, Quickbooks, for example, can pull the data you need instantly, which helps streamline the process.
But recasting can get a lot more complicated with disorganized records and ineffective accounting systems. You might need to clean up your data before the recast can begin. Data cleanup can take anything from hours to days, so start early to avoid delays during due diligence.
The Limitations of Recasting Financial Statements
A financial recast, while useful, isn’t a financial audit and will likely come under scrutiny during due diligence. There’s no tying line items to bank statements or receipts. If there are errors in your accounting, a financial recast might not catch them. All it does is restructure data that already exists. If you’re concerned about the validity of your financial records, speak to an accountant for expert advice.
Buyers can also challenge the adjustments, so prepare to justify them. Your idea of discretionary spending might differ from theirs. For example, say you invested heavily in a one-off marketing campaign to achieve a spike in growth. You might argue that now you’ve won the customers, the buyer won’t need to repeat the same campaign. The buyer, however, may want to invest in similar campaigns to achieve the same results. Prepare to negotiate on things like this before signing an APA.
Financial recasting is an essential step in preparing to sell your business. We’ve seen thousands of company financial statements including unnecessary personal expenses, which can lead to low-ball offers and restrictive terms. For a better outcome for your acquisition, see if you qualify for expert help from our M&A team today.
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