Why Clean Books are Important for a Smooth Transition
Most business owners underestimate the necessity of maintaining orderly records when running a business or planning to sell the company. Recordkeeping may be tedious, but sloppy recordkeeping hinders one’s ability to make decisions and plans.
A company’s books of accounts reflect its financial health and potential for growth and increased profitability.
“Clean Books” Explained
If cleanliness is next to godliness, clean books might be considered the holy grail of business administration.
The definition, criteria, and scope of “books” differs across businesses but always refers to the repository of a company’s financial information, without which savvy decisions cannot be made. Having “clean books” means that such information is maintained in good order and kept up to date for better cash flow management. Sloppy or inconsistent recordkeeping leads to inaccuracy which may either slow down the process of claiming receivables from customers or delay payments to vendors. Both scenarios hurt cash flow.
Also, clean books are not only well organized, but they are also comprehensive and include an accurate balance sheet and income statement, reconciled bank accounts, matched expenses and revenue, and other crucial accounts at each month’s end. Clean books also help to maintain an optimum level of inventory.
Importance of Clean Books
Clean books are critical to:
- Attract prospective buyers
- Differentiate between the assets and liabilities of the company and the business owner
- Overcome concerns and meet requirements when filing taxes
- Guide business plans
- Ease transition under new management.
Attract Prospective Buyers
When selling your business, prospective buyers want to look at its financial records from the past three to five years. The state of your books of accounts reveals the ongoing condition of your business.
Every ready-to-sell business must pass through prospective buyers’ rigorous due diligence process. The process is intended to identify any financial issues, legal issues, liabilities, and other concerns. The results of due diligence may make or break the sale. Clean, accurate, and current records indicate transparency: you have nothing to hide. Transparency and candor build confidence.
Prospective buyers expect clean books which help them compare your business with industry peers. Inaccurate accounts may result in incorrect growth estimates. Decisions based on incorrect financial information are bound to go wrong.
Your financial records represent the quality of your business. Clear, well-organized financials create a good impression on prospective buyers, and disorganized, convoluted financial records make buyers suspicious about the company’s health and may lead them to undervalue the business or walk away from the sale.
Differentiate Between the Assets and Liabilities of the Company and the Business Owner
When preparing your business for sale, you must distinguish between your personal expenses and assets (which will not be included in the transaction) and those belonging to the company. The inclusion of personal expenses and assets in the company’s books may drive potential buyers away. An exit planning advisor can help you adjust your books to separate personal expenses before presenting your company’s financials to prospective buyers.
Overcome Concerns and Meet Requirements When Filing Taxes
Government agencies and insurance companies perform audits for income tax, liability insurance, sales tax, worker’s compensation, payroll tax, etc. Failure to accurately report and pay taxes can bring businesses down and lead to costly litigation, punitive fines, and possible incarceration.
Clean books ease the audit process; messy books make it difficult, complicated, and expensive. Investing in clean books helps avoid tax nightmares.
Clean books also simplify the identification of tax obligations at the end of the year and streamline the tax filing process. They may help reduce your tax burden by highlighting areas where tax deductions are applicable. Well-organized records will help you make timely decisions to change the business structure (LLC, C-corporation, S-corporation) to suit your unique taxation situation and lower your tax burden.
Guide Business Plans
Clean books help you make informed decisions based on accurate information. They facilitate decisions concerning the purchase of new equipment or machinery by providing a clear picture of available cash, accounts receivables and payables, and the income statement.
Clean books reveal the company’s accurate financial health, regardless of cash levels which can be deceptive. For instance, retail business owners collecting money upfront from customers and paying suppliers on terms may get a false sense of security due to the cash level if they do not have clarity on the overdue payables. Similarly, a low cash balance may cause panic if accounts do not reveal the level of receivables pending collection.
Clean books help identify patterns in the business by spotting spending trends to facilitate a reduction in expenses.
When it comes to exiting one’s business, clean books inform the owner’s decisions on when to sell, how to sell, etc. They support correct enterprise valuation and help achieve the right sales value. Sloppy books result in buyers setting a lower valuation for your company.
Ease Transition Under New Management
Clean books help forecast income and track business growth while achieving financial and business targets, making planning and achieving a smooth transition easier. Clean books allow business owners to identify changes in the financial situation, such as when the company’s value reaches the exit goal, and it is time to sell.
Accurate and updated books of accounts reflect the company’s correct financial situation and streamline the preparation of year-end financial reports, statements, and accounts.
Clean books help new management keep the business running and reduce liability after the ownership transition. Prospective buyers can use these financial statements to study the existing management situation and spot opportunities to improve operations under their leadership.
How Buyers Protect Themselves
Buying a company may create liability issues for prospective buyers, so they carry out thorough due diligence and structure the transaction according to the results of their investigation. The business owner should understand the depth of the inquiry to rectify any possible issues and avoid a situation that might lead to the buyer walking away from the transaction.
When purchasing assets, prospective buyers want to ensure there are no liens on them. Therefore, they will search financial and legal records to verify your property ownership. Prospective buyers will contact the local government offices to determine whether your company has the appropriate licenses and permits for the property’s current use. They will check your company’s tax situation to ensure you have paid all taxes. They will check for bankruptcy filings, employment rights violations, or pending lawsuits concerning your company. They will contact the Workers Compensation Board to ensure that you are in good standing.
They will examine several documents, including audited financial statements, incorporation documents, contracts, board meeting minutes, inventory lists, etc. And most importantly, they will obtain good financial and legal advice before moving forward with the ownership transition.
Maintaining clean books is the first step toward addressing every inquiry and achieving a successful transaction.
Why wait for a government agency, buyer, or bank mandate to put your records in order? Clean books provide immense benefits in running a business and achieving a smooth ownership transition. Seek guidance from expert advisors on how to clean up your books.