|Five Things Your Accountant May Not Have Told You (But a Business Buyer Will)
The majority of small business owners in the green industry do not have a particularly strong relationship with their outside accountants. They usually look to them for tax return preparation, keeping out of tax trouble and helping them deal with it if they do find themselves in tax trouble. In some cases, they get involved with tax planning, and that is often about it.
There is so much more benefit that a business owner can get from a closer relationship with his or her accountant. Many accountants will welcome the opportunity for a closer relationship. Their advice and counsel is often some of the best advice you can get, particularly if you have had a relationship with them for a period of time and they have had the opportunity to really understand your business.
But most accountants are pretty busy people, especially during tax season. In most cases, they will not push for a closer relationship unless that is something you specifically ask them for. If you are looking for ways to improve your business or to prepare your business for the process of selling it, time spent with your accountant will probably be time very well spent – and if it’s not, you may need a new accountant who is more in tune with your needs. Accountants have usually worked with hundreds of different businesses over many years and the experience they have will likely include working with other business owners who have faced issues similar to the ones that you are facing. The opportunity to take advantage of that experience is one of the main things your accountant should bring to the table.
When you have a more limited relationship with your accountant, you will probably not get the maximum value from him or her. And the fault is mostly yours, not theirs. If you send signals to your accountant that all you are interested in is having your tax return completed by a certain date, you will likely get your tax return delivered – and not much else.
Here are five things that will have a great deal of impact on you and your business that you may never have discussed with your accountant.
1. Timely financial statements are important.
Many small business owners in the green industry have an outside accountant compile financial statements on their behalf. Some businesses have their accountant prepare only annual financial statements. Others may have their accountant prepare them quarterly or monthly. Unfortunately, many only have financial statements prepared annually when their tax return is complete. Making matters worse, many businesses have their accountant extend the due date of their tax returns routinely, making them due, for calendar-year taxpayers, on September 15. Financial statements prepared at that time are of very little value to anyone. It may satisfy some requirement of your bank, but they certainly are not helpful in running your business, and they do not provide the kind of up-to-date information a potential business buyer would be looking for.
2. Accrual-based financial statements are important.
In many cases, the financial statements that outside accountants prepare are compiled on an income tax-basis, instead of in conformity with “generally accepted accounting principles”, which require accrual financial statements. Some tax preparers may only be skilled in preparing tax-basis financial statements because of their training. If your accountant is a CPA, he or she will be familiar with GAAP financial statements, but still may not routinely compile them if his or her practice is primarily tax-related.
What are the differences between tax basis and GAAP basis financial statements? The biggest difference is that tax basis financial statements are often prepared on a cash basis (if the taxpayer qualifies for using the cash basis for tax purposes, which many green industry businesses do). Basically, cash basis only recognizes cash transactions; revenues are recognized when received, and deductions are allowed when the bill is paid. GAAP financial statements are prepared on an accrual basis; revenues are recognized when earned, and expenses are recorded when incurred, regardless of when the revenues are actually received or the expenses are paid. As a result, GAAP financial statements reflect accounts receivable and accounts payable.
Another typical difference between tax-basis and GAAP financial statements is how depreciation is handled. The tax-basis financial statements will include depreciation as it is deductible in the business’s tax return. For many green industry businesses, the Section 179 deduction has allowed a significant portion (sometimes all) of the business’s capital expenditures to be deducted in the year the asset was acquired. For assets that are not eligible for the Section 179 election, accelerated depreciation is usually available. In most cases, GAAP financial statement use straight-line depreciation over the asset’s estimated useful life. In the early years of an asset’s life, straight-line depreciation will be lower and may be a better indication of the ongoing capital expenditures required to support the business, a matter of considerable interest to a potential buyer. In some cases, accelerated depreciation may be appropriate for GAAP financial statements. Depreciation is important because it provides a starting point for evaluating the ongoing capital expenditure requirements a business buyer may reasonably expect.
Accrual-based, GAAP financial statements are intended to portray the economic impact of the business’s activities during the period, as opposed to compliance with tax reporting. As a result, the accrual financial statements are the ones that should be the most helpful to a business owner in running his or her business and be of most interest to a potential business buyer. That is not to say that income tax information will not also be of interest to a business buyer, but it will not be the most important thing.
3. Accounting data can help you manage your business.
Many business owners and some accountants view accounting record-keeping as primarily a compliance function – what it takes to prepare tax returns and keep the business owner out of trouble. It can and should be much more.
My experience is that every successful business owner uses pieces of information to manage his or her business effectively. There are often just a few key data points that a business owner or manager focuses on to keep an eye on the pulse of the business. Sometimes that data is included in accounting reports the owner receives on some sort of schedule. Probably just as often, it may be on a sheet the owner keeps in his or her desk drawer, maybe even on the proverbial back of an envelope. You often hear the proverb, “you can only affect things that you measure”. Measurement is what accounting is all about. The accounting system should support you as a manager with the data you need to manage the business. If you find yourself managing from the back of an envelope, it is time to rethink your accounting system and the information it is providing you. Another sign that it is time for an investment in accounting systems is when you, as the business owner, or others, such as your banker, frequently ask for data your accounting system can’t provide.
Having an accounting system that actually supports the business on a daily basis is one of the key steps to preparing to take your business to the next level of growth and profitability while maintaining control. It is a sign of business maturity that will be appreciated by a potential buyer.
If your accountant does not either have experience in working with companies similar to yours or take the time to seek out industry information, the financial statements that are compiled my not look like those prepared by similar businesses in your industry. This will make it difficult for you to compare your operating results to those achieved by other companies or to published industry benchmarks. Some problems you may see in your financial statements that will make it difficult to compare results may include such things as which operating expenses are considered cost of sales and deducted from net sales to arrive at gross profit. If you cannot break out administrative salaries from the operations payroll, it will be difficult to calculate a meaningful gross profit figure.
4. How you manage working capital will affect the value of your business.
Business owners in our industry often think of rules of thumb as to what their business is worth. Those rules of thumb are usually not very helpful unless they are, in essence, a proxy for cash flow. Cash flow is where it’s at for business valuation and business buyers. A rule of thumb based on revenue is only going to work if your business has a typical margin. If your margins are stronger than typical, your valuation will usually be higher (if the buyer believes it can continue to earn high margins on your business). If your margins are lower than typical, your valuation will usually be lower. A potential business buyer looking at your business for potential acquisition is going to be interested in the cash flow they can expect to be able to generate from your business after the acquisition has been completed. They are also going to be very interested in how much cash, in addition to the purchase price, they will have to put into the business. What would cause the buyer to have to put additional cash into the business? Two typical examples will be capital expenditures and working capital. A buyer will have to analyze its likely capital expenditures (often called “capex”). Capital expenditures will be required if the seller’s fleet and equipment is old and maintenance has been deferred. Capital expenditures will also be higher if the buyer’s policies on such issues as how long they keep vehicles are different than the policies of the seller. Two similar businesses can be operated in ways that can produce significantly different working capital requirements.
Perhaps the most important decisions affecting working capital involve billing and collection policies. Do you bill for this month’s services at the beginning of the month or the end of the month? If it is at the end of the month, the buyer will have to invest additional cash into the business before it begins to generate cash. How do you make sure your accounts are collected timely regardless of when bills go out? Businesses with better collection experience will have lower working capital requirements and command a higher valuation. The other major element of working capital is accounts payable. This is a bit more of a dance, but in general, businesses that manage the payment of accounts payable carefully, paying bills when they are due, but not before, are going to have lower working capital requirements and a greater value than a business built on paying bills immediately when received.
5. An in-house accountant may be the best investment you ever make.
Small business owners are not usually looking for ways to spend more money. Hiring an experienced accountant, possibly a controller or a chief financial officer, is often not high on a small business owner’s list of priorities. The term “small business” covers a pretty wide range of businesses, encompassing the vast majority of businesses in the green industry. When does it make sense to add a professional accountant, perhaps a CPA, to the team? Maybe when you cross the $5 million threshold? Some people do it earlier and some a little later. What I can tell you is that many business owners consider their decision to add a professional accountant to the team the single best decision they have ever made. It is an important step in the process of becoming self-reliant. Once you cross this barrier, you no longer are dependent on the occasional conversation with your outside accountant; you have that access all day, every day. Evaluating the financial impact of decisions becomes a part of the routine management process. You can move more aggressively on such things as considering acquisitions because you are not as dependent on your outside advisors. And even the process of managing your relationship with your outside accountant becomes easier because that is usually a part of your CFO’s job description. Another part of the CFO’s typical job description is evaluating the systems you are using to run the business and looking for ways to make them more efficient and effective. The pay-off from adding an in-house professional accountant can be dramatic.
This article may have given the reader the that a typical small business does not have a good relationship with its outside accountant. That has not been our intent. In fact, many small businesses in the green industry have a great relationship with their accountants. Even so, many of them could gain a much greater competitive advantage with a stronger relationship. That advantage can pay dividends in operational performance and make a big difference when it comes time to consider selling the business.