Quality CPA = Quality Financial Statements

And Why it Matters! 

by Robert J. McCormack, Managing Partner, Murphy McCormack Capital Advisors

Cormack Capital Advisors

After spending almost 30 years in the financial services industry, as a commercial banker, bank president and investment banker, I can state with certainty that there is one overriding issue that too often negatively impacts business owners' ability to access debt or to sell their businesses.  That issue is:  failing to engage a quality CPA that will produce quality financial statements.  It is an issue that can be detrimental to any business, but for a business seeking debt or seeking succession through a sale, it can derail the entire process or lead to a lower valuation, less attractive structure, more stringent loan covenants, and a lengthy process. 

Five Things You Can Do to Improve Financial Reporting (and make it easier to get financing or maximize the value of your business)  

1.  Get Rid of the Noise

If you are considering borrowing money or selling all or a portion of your business, it is important to get the "noise" out of your financial statements.  By "noise," I mean things like significantly under-reporting inventory, running personal expenses through the business, failing to record sales, paying family members that don’t actually work in the business and similar items.   

2. Accrual Financial Statements

Most lenders and buyers prefer, and many require, accrual financial statements.  Accrual financial statements are generally considered to be a more accurate and complete reflection of what is really happening in a business.  So, while taxes may be reported on a cash basis or an accrual basis, it is to your benefit to have CPA prepared financial statements on an accrual basis.   

3.  Consolidated and Consolidating Statements, when necessary

If there are related companies, with intercompany transactions, it is worthwhile to have the CPA prepare consolidated financial statements with consolidating schedules showing the eliminations.  This gives the lender, investor or buyer a clearer picture of the entity(ies). 

4.  Notes to Financial Statements

For most buyers or lenders, the notes to the financial statements are as important as the financial statements themselves.  The notes provide key information such as depreciation and inventory methods being applied, details of long term debt, pensions, leases, income taxes, contingent liabilities and similar information. 

5. Compiled, Reviewed or Audited

It ties in to item #4, but to elaborate...  If you are considering selling your business or acquiring a sizeable loan, it is to your benefit to move to reviewed financial statements, at a minimum.  A  quality reviewed financial statement will provide the notes described in item #4, segment reporting if appropriate, and will give a potential lender or buyer confidence in the numbers.  Some buyers or lenders may require audited financial statements. 

The Benefit to You

First, many bankers and buyers rely on the financial statements as a key to their decision making.  If the statements are not thorough or have "noise" in them, bankers/buyers often ask themselves, "If I can't rely on the financial statements, what else do I need to be concerned about?"  At this point the buyer may lower the offer or walk away, and the lender may doubt the ability to support debt service, change the structure, add more stringent covenants or walk away, as well.  Quality financial statements prepared by a quality CPA can eliminate or mitigate many of these issues.

Impact on Valuation

To illustrate the impact, here is an example.  Company A and Company B are in the same industry.  Company A accurately reports inventory following generally accepted accounting principles, while Company B under-reports inventory by $1 million. 

When buyers have confidence in the accuracy of the financial statements, they are typically willing to pay a higher multiple.  If there are inconsistencies in the financial statements, or inaccuracies between the financial statements and reality, that leads to questions and concerns from buyers, which can translate to a lower multiple or simply choosing not to pursue a transaction. 

While Company B saved (or deferred) paying $400,000 in taxes, the impact on valuation is tremendous.  Company A, which accurately reported its financial performance, had a valuation more than double that of Company B. 

I can’t stress enough, the importance of having a quality CPA.  A key point here, as well, is that there is a significant difference between a quality CPA and a tax preparer.  A quality CPA or CPA firm is likely to be skilled and knowledgeable and accounting, financial reporting and tax preparation, while a tax preparer may not be a CPA and may have no experience with business transactions.  A quality CPA can fairly and accurately present your financial performance while legally minimizing your taxes. 

Choosing a CPA 

How do you find a quality CPA firm?  One of the best ways is to talk to people:  ask your commercial lender, your peers or area investment bankers for recommendations.  Ask the firms you are considering to provide references and check the references.  Finally, don’t focus purely on price;  focus on the complete value proposition of the CPA firm.

 ###

 Bank Financing in Today's Environment