One of your favorite pastimes is sitting at your lake house, looking out over the water, and reminiscing about the origins of your success. You worked hard for this. You were not “born on third base” or with the proverbial “silver spoon”. You worked for everything you achieved. This feeling of accomplishment is deeply satisfying and perhaps worth more to you than the wealth you’ve accumulated over your career at the helm.

You chalk your success up to thrift, hard work, innate business instincts, with some good fortune mixed in.

You have never, really looked at the financial statements prepared by your CPA and provided to your bank annually. What’s the point anyway? What matters is minimizing the taxes you pay and maximizing the cash transferred into your personal accounts each year, right? Until you sell your business.

If someone asked you about your sales or profitability trends over the past five years, you would almost instinctively respond, “Sales are up, profits are up, everything is moving along nicely.” But is this true?

The story you tell yourself about the business does not always match the story of your financial statements.

Offset Earnings Volatility In Your Financial Statements

From an investor’s perspective volatility equals risk. Predictable, stable, and recurring at the words investors like. When they see financial statements that bounce all over the place like a ping pong ball, it raises a lot of questions that can lead to places you as the seller do not want them to go.

Shifting from Cash to Accrual Accounting

If you think you might want to sell one day, an important step you can take proactively is to adopt accrual accounting. Most businesses run on cash accounting, or what I call “modified” cash accounting.

By way of example, most businesses pay their annual property & casualty insurance policy premiums once a year. Under cash accounting, your insurance expense will spike in this single month and remain $0 for the next 11 months until you pay next year’s premium. Under accrual accounting, this payment would be booked to an asset account called prepaid expenses and insurance expense would be recognized evenly over the 12 months. The end result of accrual accounting is to better replicate the activity in the period, regardless of swings in cash.

You can make this shift by hiring or contracting an accountant to develop and implement a monthly or quarterly closing process. This step will ensure your financial statements are prepared in such a way as to avoid what we can call “mechanical” volatility, which would be swings that are purely related to accounting in a non-accrual way.

Set Targets and Manage to Them

Once you have established an effective process of generating your financial statements, the next step is to learn them. These are the most important documents you will produce in the sale of your business. There is nothing more critical.

If you learn your financial statements, you can then set meaningful targets based upon your goals and knowledge of your business. This will open you up to the possibility of then managing the targets you set.

Once again, let’s take an example. You are faced with two potential business opportunities. One that is large and one-time in nature and a second that starts small, but is expected to grow consistently for years. Under a cash accounting system with no targets, you might have taken the one-time project. But under accrual accounting with targets, you are more likely to take the recurring opportunity.

Making the Shift

These kinds of shifts can feel monumental, and the results that follow them can be. Perhaps this article is the first time you heard the term “accrual accounting”. Don’t let the terminology overwhelm you. Just reach out for help, Doescher Group specializes in helping you achieve your exit goals. Part of this is improving your financial data and getting ready to put your best foot forward in your company’s sale process.

If you want to learn more, but don’t know where to start, reach out, that’s what we’re here for.