What is a balance sheet and how important is it when you’re selling a business?
Every incorporated business in the United States is obliged to have a balance sheet. It is not mandatory for partnerships and sole proprietorships but it is highly recommended that these small businesses adhere to this sound accounting principle. A business’ balance sheet is one of the best ways to demonstrate the financial health of the company. It demonstrates financial diligence on the corporation’s part. For the buyer, three financial statements you absolutely should receive from the seller are the income statement, the balance sheet, and the cash flow statement.
It’s easy to focus solely on your business’ tax returns and income statements and ignore the balance sheet. The reality is that the lack of a balance sheet that accurately reflects the operation of the business is a real hindrance when it comes time to raise capital, secure supplier relationships or exit your business. Here are a few important reasons to keep a balance sheet.
1. A balance sheet gives a comprehensive overview of the health of a business
Your balance sheet should display in a manner that is easy to read and follow the business’ assets, liabilities, earnings, and equity. Assets include cash, land, infrastructure, and equipment. Assets may be tangible or intangible, movable, or immovable. Liabilities include the payroll, utilities, interest, employee medical insurance, building rent as well as any contributions you’re making to pension plans. Equity refers to what’s left after liabilities have been subtracted from the assets. And finally, retained earnings is the profit that the business gets to keep, these are earnings that are not shared with the shareholders.
2. The balance sheet may be used to meet financial obligations
Interested parties looking to buy your business may want to understand how they will be able to meet their financial obligations. Perhaps they will want to sell shares of the company. They can only do this if they have an idea of the company’s financial position. From the balance sheet, they’ll be able to analyze potential rates of return and also have a snapshot of the capital structure. As a buyer what are you hoping to achieve with the business in the next few years? Do you want to grow the business beyond its current setup? Given the liabilities and assets in possession do they give you leeway to expand or debts may restrict your ambitious goals?
3. The balance sheet may be used to secure lines of credit
According to a survey carried out by the Small Business Administration, at least $600 billion is loaned to small businesses every year. And just what is the average loan amount? In 2017, the average amount loaned to SMEs was $663,000. It’s not hard to see that investors are very happy to seed money into ventures that look lucrative and promise to deliver credible returns.
One of the biggest reasons sole proprietorships and partnerships find it difficult to secure lines of credit is a failure to show a balance sheet. The ability to show creditors good accounting records gives them the confidence to release funds. A business’ balance sheet will be able to demonstrate that the business is in a good place and has the potential to become bigger with the right financial muscle backing it up.
4. A balance sheet can show areas that need improvement
A balance sheet is like a doctor’s report. It shows the areas that need improvement, the areas that are in good shape, and those that could do with a little more attention. To add on, the balance sheet can also highlight specific places that are causing the business to lose money. Perhaps its overhead costs which need to be lowered – moving into a smaller space, downsizing the company, or finding contractors with cheaper equipment to hire. Maximizing value can only happen when you can clearly see what’s working and what’s not.
5. A balance sheet shows a good financial practice
If the corporation is already listed on the stock exchange or you’re still in the initial stages of preparing to go public, your financial statements will be appraised to ensure that everything checks out. Government agencies, stock, and banking regulators use a company’s balance sheet to screen for possible financial malpractice. Fraudulent activities can often be tracked on balanced sheets. By regularly going through a public company’s balance sheet, stock market regulators are able to detect any financial malpractice.
6. Win the trust of your suppliers with audited balance sheets
Most businesses rely on suppliers and creditors to stay afloat. If you’re running an operation that needs you to purchase raw materials from another company, having good credit (which can be shown by your balance sheet) is a surefire way to win their trust. Suppliers want to do business with companies they know are reliable and trustworthy. Hence the importance of a balance sheet can never be overestimated if you’re building a business.
7. A balance sheet allows for efficient business management
In order to manage the company efficiently, it’s key to know the numbers – debt funding status, current cash flow, asset investments, status of trade receivables, and company liquidity situation. Planning for future expansion is only possible if you know how the company is doing. Looking at the balance sheet as a buyer you might also be able to see whether or not there is a future and other hidden reasons the seller might be selling.
Discuss financial statements with a business broker
Business brokers such as Sun Acquisitions have decades’ worth of experience working with
buyers and sellers to get their business papers in order before a sale. Sit down with an experienced broker and go over your dossier as part of your financial diligence process. Work with the best broker team in the industry and contact us today.
Get in touch with one of our advisors to learn more about how Sun Acquisitions can help during business mergers and acquisitions.
Disclaimer: Any information provided in this blog is not intended to replace legal, financial, or taxation advice given by qualified professionals.