A Seller’s Guide to Financial Reporting

We’ve all heard the adage “the numbers don’t lie”, and while this is true, the story that they tell is best understood when accompanied by insight on the surrounding business context. Digging a few feet deeper on your financials to learn your numbers more intimately and collect data that supports the story of what makes the business exceptional can pay significant dividends in both unlocking value and increasing efficiency in the deal process. Below is a brief guide to the key financial reporting elements to consider as you prepare for a transaction:

1. Historical Financial Statements: Ideally, the Company will provide a minimum of five years of historical financial statements, including Profit & Loss, Balance Sheet, Cash Flow and Stockholder/Member’s Equity Statements to prospective buyers. As we noted earlier, “the numbers don’t lie” but only to the extent the Company’s statements are complete, accurate, and prepared consistently. Consider obtaining greater levels of assurance on financial statement reporting by engaging with your CPA early in the transaction planning process. For Company’s with only internally prepared financial statements, consider upgrading to a compilation or review. For Company’s with financial statement reviews, discuss with your transaction advisor if a financial statement audit would materially improve the terms of your transaction or your chances of obtaining competitive financing terms.

2. Projected Financial Statements: No one has a crystal ball, but the reality is that a buyer is purchasing the future cash flows of the business, not the past, and therefore projected financial information is critical to a transaction. Typically, five years of forward-looking projected statements are requested. The good news is that projections can’t and won’t be perfect, but instead need to be reasonable and prepared in good faith based on the Company’s expectations and knowledge of the business. If projected financial statements or annual budgeting is not part of the Company’s normal practice, discuss this early with your CPA and transaction advisor, and consider the following starting points for a projected Profit & Loss Statement:

• • Review historical annual growth rates of sales and weigh how confident you are in those growth rates continuing. Sometimes past performance truly can indicate future performance.
  • Consider new products or service capabilities that you expect to contribute to future sales growth. Similarly, consider if certain low-growth or low-margin products or services will be retired in future years.
  • Analyze how product or service pricing inflates over time, whether in line with general market inflation or governed by long-term agreements or other factors. It is critical to incorporate inflationary growth into sales projections (i.e. expected growth if sales volume did not increase or decrease).
  • For expense items, consider each category of direct costs of sales and whether any production or labor efficiencies are expected in future periods. As a simple starting point, review historical gross profit margins and any factors that may contribute to material changes. For example, future changes in vendors or vendor pricing, changes in direct labor costs or shifts in mix of employed vs. subcontracted labor can drive notable changes in gross profit.
  • For selling, general and administrative expenses (i.e. rent, salaries & benefits, marketing, etc.), consider reviewing each category to determine to what degree each category would be impacted by top-line sales growth. Further, consider inflationary increases, such as expected annual salary cost of living increases, contractual rent increases or planned changes in employee benefit plans or insurance arrangements. Often historical results and projections will demonstrate economies of scale as the business grows.
  • Consider future cash flows needed to acquire fixed or intangible assets and what portion of the cash need is strictly to maintain the operations of the business versus capital spend that will facilitate growth.

3. Key Performance Indicators (“KPIs”): Every business has keys to success and often these can be measured in a financial ratio or metric. Consider making a list of the keys to the business and what reporting and data are available. Start with foundational metrics such as sales units by product or service line, sales or profitability by customer or geography. To the extent you have the ability to compare these metrics to industry averages or peer group metrics, this can help drive the argument for value of the Company. Consult with your transaction advisor to consider other opportunities to demonstrate performance metrics that drive value.

4. Monthly Reporting: Prospective buyers will expect interim financial reports to be made available. For many Companies that historically report quarterly, preparing to shift to monthly reporting can significantly aid in the transaction process. Ensuring accurate monthly reporting can facilitate fair and accurate negotiations relating to the Company’s normalized working capital, and can help explain seasonal changes in the business and balance sheet accounts.

Engaging a transaction advisor that can work hand-in-hand with the Company’s internal and external finance professionals to collect and review financial data can improve the overall outcome of a transaction. When reporting is consistent and reliable, buyers gain greater comfort in the data being presented and the sell-side can more seamlessly advocate for full and fair value. At Lazear we are here to assist with these critical early steps in transaction planning, and with a team boasting numerous former CPA professionals we are here to help!