Why are financial statements crucial when selling your business? 

Owning a business can be a great road to financial freedom.

And for many people, buying an existing business can be a good option. You don’t have to reinvent the wheel, since the previous owners have already established a successful formula to run the business.

If you already own a business and you’re thinking about selling, it’s worth knowing what buyers are looking for. The Ministry of Business, Innovation and Employment says you can prepare by knowing that:

“potential buyers will want a thorough look at your finances to make sure they’re buying a sound, profitable business…To get the best return on your investment in a business, you need it to be in the best shape when it goes for sale.“

In this week’s blog, our guest business broker, Susan Han, discusses how crucial it is to have good financial statements to demonstrate your business’ profitability. As you will see in the outcome of her case study, if your financial statements don’t reinforce your asking price, it is much harder to achieve a good price when you sell your business.

1. Nowadays, why are financial statements crucial when selling your business?

In the past many people, especially Asian buyers, used cash to buy existing businesses. However, cash sales are becoming less common. What are the reasons for this change in New Zealand’s business market?

In 2018 the government launched the Anti-Money Laundering Act (AML act). Under this law, all banks are required to do more to verify a customer’s identity and account activity, which certainly makes it harder for Asian buyers to transfer their overseas money to New Zealand.

The Bank of Mum and Dad remains a popular way for young people to buy a business in New Zealand. However, considering the potential effects of the AML act, many foreign-born buyers must now borrow to buy a business.

When it comes to business loans, banks will check a business’ financial statements to evaluate its profitability, helping banks decrease the risks associated with loan repayment. If the financial statement shows that the business doesn’t make enough profit, the bank won’t approve the buyer’s loan application. So, from a seller’s perspective, it’s crucial to make sure your financial statements reflect your business true performance.

2. It’s hard to sell your business if you only declare a small amount of your cash income.

A cash business is an enterprise that mostly runs on cash transactions. For example, a restaurant can be classed a cash business because they take cash regularly. Accepting cash and paying in cash is legal. However, some small business owners do not declare their cash income, or only declare a small amount of it. It might help them “save” in tax (which really means tax evasion which is illegal) but their financial statement looks not as profitable as it should. Consequently, it could be very hard for them to sell their business for a good price because their potential buyers might not be able to secure a business loan.

Here’s a case that Susan shared with us that illustrates this problem:

A young Chinese couple wanted to buy an existing café. The purchase price of the café was $500,000. They didn’t have enough cash, so they considered asking their parents for help.

When the solicitor asked the couple to prove the source of their money, they couldn’t give sufficient evidence due to their parents’ personal reasons. So, they had to apply for a business loan instead. However, based on the financial statement, the business wasn’t profitable because the owner hadn’t declared all cash income. Consequently, their bank declined their business loan.

The above case is increasingly common, with 80% of buyers now needing loans to purchase an existing business. However, in the past, only 20% of buyers would need a business loan.

3. Compared to the past, how do today’s buyers evaluate the value of a business?

Buyers have always placed significant emphasis on the value of a business. In the past, business buyers often counted the number of customers a store got on a given day - measuring foot traffic to estimate the turnover of a business. Because they didn't have to borrow, so they weren't so much rely on financial statements. Instead of financial statements, buyers used this traditional way to evaluate the value of the business.

However, in today’s market, they have to borrow from banks, and banks rely on financial statements to evaluate buyer's ability to repay loans.

Susan highly recommends business owners keep a current record of their profitable status with up-to-date and accurate financial statements. This helps owners sell their business in the future at a price they are satisfied with.

4. Looking to buy a business in New Zealand?

Susan Han and her husband Henry Han are professional business brokers at Link. They have built strong relationships with many different people in business. Their understanding of different cultures is very valuable to business owners and purchasers alike.

Susan understands small businesses and is fully committed to assisting vendors and purchasers in achieving their needs, by building rapport and maintaining good relationships. You can contact Susan via phone 027 566 8938/09 555 6066 or email: susan.han@linkbusiness.co.nz

Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.

Prosperity Finance - here to help

Prosperity Finance understands the complexities behind the business loan application process. We manage your business loans from beginning to end, and empower you to make the best long-term, informed decisions. As professional business loan brokers, we’re here to help. Give us a call today on 09 930 8999.

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