Boosting Business Value By Recasting Financial Statements
For many entrepreneurs, selling a business they have invested time, energy and resources to build is never an easy decision to make. Many consider passing the business on to family or trusted employees to continue their legacy. However, you will effectively learn that business decisions must not be predicated on emotion. It is more advisable to sell your business to an individual or entity that is well-qualified and fully committed to making it succeed. There is a better guarantee for the continuation of your legacy than leaving it to a family member or placing it under the care of a friend. The buyer would ensure greater growth and the achievement of organizational goals. Therefore, the dream that you actualized in the form of a business does not die with your inability (or unwillingness) to continue steering its growth.
Once you decide to sell, there are many measures that you must take to ensure that you get the right deal. The first step is to analyze and establish the actual valuation of your business as currently constituted. This includes identifying the potential for growth in the future. This process gives you an insight of your business’ worth and ensures that you get the right value for your business. The first step in the valuation of a company is recasting. This step is so important that it could lead to a gross undervaluation or overvaluation of a company if done incorrectly. The irony is that you would ultimately suffer a loss because of a situation which was created deliberately for tax purposes.
Financial Recasting Explained
Recasting is the process by which a company seeks to amend or re-release P&L and balance sheet docs statements which had already been published (either internally or publicly), but with clear and specific adjustments in preparation for a capital transaction. Business organizations often under-report their earnings to reduce the amount of taxes that they have to pay. Once this is done, it has to be maintained, since reporting the right earnings abruptly would then increase the taxes exponentially. This would hurt the business financially, sometimes in a way that it may not recover. It is important to note that this is entirely legal and allowed for under the law. It is therefore common practice among many business entities. However, such reported earnings could hurt the valuation of your business if not corrected before you sell your business. This process of fixing earlier reported financial reports is referred to as recasting. It enables buyers to get an accurate assessment of the profitability of your business. This, in turn, allows them to determine its real value and potential for future growth.
When buyers seek to acquire a business, they use a formula known as EBITDA to determine its value. EBITDA refers to the company’s earnings before interest, taxes, depreciation, and amortization. This way, if a buyer has several investment opportunities, they compare all their EBITDAs to determine which one has a more promising future and is, therefore, a better investment opportunity. For a better business valuation, many aspects of the EBITDA formula can be recast to give a more accurate representation of the organization’s financial well-being. This, therefore, paints a more promising picture for the future. Some of the aspects that can be recast include:
1.Owner salaries and bonuses: The salaries of the owners and other shareholders working within the business are usually significantly higher than those of the other employees. The buyer does not, however, have to adhere to such salary ranges upon acquiring the business.
2.Non-arms-length revenues or expenses: This refers to transactions in which the company pays more or less than the market value. An example of these may be transactions with a supplier with whom the organization owners may have a personal relationship. Such a supplier may give the organization a considerable discount. The new buyer does not have to keep such relationships, and will therefore not realize the revenues or expenses born out of such transactions.
3.Revenue or expenses from additional assets: There are assets which do not bring the organization many benefits. They do not affect its productivity or operations in any tangible manner. The new buyer is under no obligation to keep such assets, and would therefore not realize such expenses or revenue.
4.One-time fees: These are expenses that are incurred once in circumstances which are exceptions. These are circumstances that are not likely to reoccur, such as a lawsuit or a one-time capital expenditures.
All these expenses and revenues are contained in the business’ returns as submitted to the government. Although the information may be accurate in itself, the context within which it is presented renders it subject to review. It must be reexamined to determine its relevance to the transaction and the manner in which it would affect the final deal valuation. In effect, all expenses and revenues which the new buyer may not incur or realize respectively are removed from the reports in the recasting process. Further, those revenues or expenditures that are as a result of relationships which the new buyer is not a party to are also removed from the reports in the recasting process. This is because the employer has no obligation to keep such relationships.
All this information has the potential to affect the valuation of your company, leading either into an overvaluation or undervaluation. It is therefore important that the recasting process is carried out promptly, and that all the reports are analyzed meticulously. This, in itself, may prove to be a difficult task which may take plenty of time and effort. Such effort would prove worthwhile, as it would ensure that you gain the right and deserved value for your company from the transaction. Additionally, once recasting is complete–even if done years prior to an eventual exit–it is advised to keep the recasted financials up-to-date to ensure shareholders have more info on expected value.
It is advisable to seek the services of professional mergers and acquisitions (M&A) professional to ensure that the process is carried out professionally. This will make sure that all the right measures are taken and that nothing is left to chance in the recasting and eventual valuation of your business.
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