What Buyers Actually Look At in Your Financials

Buyers focus on a short list of items in a seller's financials: whether three years of statements are consistent with each other and with the tax returns, whether owner add-backs are documented, how revenue is trending and how concentrated it is, how margins have held up, and whether the business generates enough cash to cover debt and pay an owner. Knowing what they will examine lets a seller fix problems before those problems cost leverage.

Consistency across years and documents

Buyers want profit and loss statements and balance sheets for at least the last three years, plus year to date, prepared the same way each year. They compare the statements to the business tax returns for the same periods.

Inconsistency raises more questions than a weak year does. If the bookkeeping method changed, if the fiscal year changed, or if the statements and returns differ, document when and why. A clear explanation offered upfront is accepted far more readily than one produced in response to a buyer's question.

Owner compensation and add-backs

Small businesses are usually priced on seller's discretionary earnings, which adds back the owner's compensation and expenses a new owner would not incur. Common add-backs include:

• Owner salary, payroll taxes, and benefits
• Vehicles and personal travel run through the business
• Family members on payroll who do not work in the business
• One-time legal, consulting, or repair costs
• Depreciation, amortization, and interest

Every add-back needs a paper trail. Undocumented add-backs are typically discounted or removed, and each dollar removed reduces value by a multiple of that dollar. See SDE and EBITDA Are Not the Same Number.

Revenue trend

Buyers look at the direction of revenue over several years and within the current year. Steady or growing revenue supports value. A decline invites questions, and the seller should be able to explain the cause and whether it is temporary.

Revenue concentration

A business where one customer represents a large share of revenue is priced differently than one with a broad customer base, because losing that customer after closing would hurt the new owner. Concentration rarely justifies delaying a sale, but the seller should know the number and be ready to explain the relationship, its history, and any contract behind it.

Margins

Gross and net margins show how efficiently the business operates and whether pricing has held up. Buyers compare margins across years and, where they can, against similar businesses. Margins that shift significantly from year to year need an explanation.

Cash flow and debt capacity

Ultimately, buyers and lenders want to know whether the business can support its purchase. After the new owner's debt payments on any bank loan and seller note, there must be enough left for a reasonable income. This calculation often determines how much financing a buyer can obtain and, therefore, what they can pay. See Structuring and Financing the Sale of a Business.

Balance sheet items

Buyers also look at what is on the balance sheet: the condition and age of equipment, inventory levels and how they are counted, accounts receivable and how quickly they are collected, and any liabilities that will need to be paid off at closing.

What to do now

Ask your CPA for a clean three-year package that reconciles to your tax returns, along with a written list of add-backs and their supporting documentation. Calculate your largest customer's share of revenue. That work removes most of the friction from early buyer conversations and prepares you for diligence. See Preparing for Due Diligence Before You Go to Market.

Southern California owners who want to see how their financials will read to a buyer can start with a confidential valuation from BusinessQuest Brokers. Request a valuation.

Frequently asked questions

How many years of financials do buyers want to see?

Most buyers want at least three years of financial statements and tax returns, plus year-to-date figures. Lenders typically require the same.

What are add-backs in a business sale?

Add-backs are expenses added back to profit because a new owner would not incur them, such as the owner's salary, personal expenses, and one-time costs. They must be documented to be accepted.

Does customer concentration lower a business's value?

It usually does, because it increases the risk to the buyer. The effect depends on how large the share is and how stable and well documented the relationship is.