Tuesday, 11 September 2012
Excessive personal expenses can lower business value!
It’s not uncommon to find business owners who take advantage of the perks of owning their own business. Who would blame them? In many cases the very idea of being able to “write-off” some personal meals, car insurance, travel, etc. is a driving force to being your own boss.
However, burying excessive personal expenses in the business financials can lower business value!
The most popular method of valuing a business uses a multiple of earnings over a period of years. Business owners should be aware of that while attempting to reduce the bottom line with personal expenses to minimize taxes. Though there are a number of deductions that may be added back to determine true cash flow, not all add-backs are considered legitimate by buyers or lenders.
Common personal expenses are auto & auto insurance, health insurance, life insurance, meals & entertainment, office supplies, phones, subscriptions, and travel. Most buyers understand these, and more.
The difficult challenge is to determine what is excessive.
First, you must document and be able to corroborate your expenses to buyers. Recently a seller couriered a shipment of antiquities from South America and expensed the cost in his retail business. It is not a strong enough explanation to suggest an allocation of freight expense as personal without receipts and proof purchase. Most buyers will assume freight cost in retail outlet are the costs of doing business.
Second, there must be a clear distinction between personal and business. It may be difficult for a buyer to rationalize 100% of the meals & entertainment expense being personal. To suggest that all luncheon expenses are with family and friends when the owners business is wholesale sales of construction supplies may be considered unreasonable to a buyer. Most buyers will assume that some portion, if not all, of that expense is to meet clients and build relationship with their customers.
Finally, sellers must understand the more difficult they make it for buyers to understand what they are buying, and perhaps more importantly, the more sellers cause buyers to doubt the legitimacy and accuracy of the financial details the more difficult they will find it to maximize their value. And, make it less likely for a successful transaction.
By securing the services of a good business broker to help the seller navigate through these issues can be good preventative medicine. A qualified facilitator will help to ensure these potential potholes are covered.
Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.