Fit for Purpose
- Posted By Andrew Morgan
The purchase of any business including accommodation businesses is predominantly a financial decision as opposed to an emotive one. When buying a house, the decision is more likely the opposite, largely emotive rather than financial. Yes, there is a hope that the value of the property will appreciate over time, but this is generally not driving the buying decision. Also, a house is considered a home for a family, or at its most basic level, shelter, rather than a money-making enterprise.
Most of those interested in buying a business do so endeavouring to gain financial benefit, to make a capital gain or provide cashflow and/or to give themselves something to do, whilst gaining financial benefit. This financial decision therefore relies on the trading of the business itself. It may be the case that a certain level of profit needs to be achieved to make it viable or maybe that it simply needs to be able to pay for itself whilst providing self-employment. The financial decision will rely heavily on the trading level the business is producing and the financial data available. Therefore, the most important piece of information to a purchaser is the financial data.
Physical presentation of the property and many other factors play a role, but the first consideration is how the financial data looks. Historical data is what first comes to mind and many love to look at it on a “trending” basis. Does the line graph track upwards or downwards? The financial status of any business plays the largest role when determining a value. Financial data that legitimately confirms the income, gross profit, expenses and profitability performance of any business. Without this in an acceptable format, no reason to worry about anything else, close the book on it. “ABC Motel is the best motel in town. The carpark is always full.” So, people say. This may be true on the surface, but if the financial data cannot confirm it, then it may not be the best or most lucrative, or even worth the value it should be in the market? Perception is reality, until the financial data comes under the microscope.
The presentation of financial data includes how the numbers physically present and the actual dollar amounts. Firstly, presentation seems so simple, however I have seen many calculation errors over the years, where the numbers simply do not compute. The total expense amount is less than what the individual expenses total, thereby inflating the profit. Are the Seller’s Accountant’s supporting documents also attached to the profit and loss statements? Is the spelling of each entry correct? People have the same issue with spelling mistakes on a profit and loss statement as they do with an email. If an email has spelling mistakes in the subject line or text, we immediately think the email is spam and discredit it. The same goes for financial statements. We start to question who prepared this profit and loss statement, surely it was not the Seller’s Accountant? We then question the validity of the statements, and the credibility of who prepared them.
Secondly, is of course the actual dollar amounts. The income & net profit must be as high as they can to achieve the highest possible sale value in the market. Therefore, I suggest to every Seller they have their Accountant prepare an Abridged Profit and Loss Statement. This will present the profit as it should for sale purposes, not for taxation purposes. It will have removed all income and expense items that are particular to the current owner, and not a part of the business. By example, an owner choosing to pay themselves a wage of $50,000 per annum, compared to another paying themselves $5,000 per annum, has nothing to do with the business, this is generally a taxation or ownership structure based decision. Simply put, one purpose of preparation is to write down the profit, the other is to maximise it.
The financial statements prepared for sale must be fit for purpose. Profit and Loss Statements are generally prepared for Taxation Return purposes and to that end, include expenses and tax deductions which inevitably present the lowest profit possible, or preferably a loss depending on each parties individual tax position. Adjustments will then be completed so the Abridged Profit and Loss Statement can be utilised for sale, refinancing or other purposes. If not, a true representation of the profitability of the motel business compared to other motel businesses would not be possible. Conversely it is also important to make sure that no legitimate operational income and expenses of the business have been removed. Even the most basic due diligence of the financial statements will determine this.
Aside from the Profit and Loss Statements being required by a potential buyer, other financial data will be required. Monthly income reports that include GST, will not match the Profit and Loss Statement. If there is consistency in the difference of the GST, the issue can be cleared up quickly. However, if this is not the case, this will create questions about the accuracy and legitimacy of the data. If there are anomalies for a particular reason, it is always best to be upfront and explain why this is the case. Trying to sweep it under the carpet and hope that the issue goes away will result in trouble.