Why are there two names for the same document when they mean the exact same document?
They were P&Ls for countless years and then the GAAP literature formalized them with the name Income Statements (which isn’t accurate when there is a loss).
P&L stands for profit and loss statement.
Regardless of what you call them they need to be right! You might have spent the last 20 years of your life building up the value in your company but today’s selling price value will be determined from your last three years P&Ls. Remember, a buyer is not paying you for all of your years of hard work. They are paying you for the future value of your company.
Note -your value will NOT be determined from your tax returns. As discussed in Topic 28, the taxable income reported on your tax returns has more than likely been “tax managed” (reported at the very lowest possible amount).
As discussed in Topic 29, clear, concise, correct accrual P&Ls are the best possible starting point for a buyer to do their financial analysis.
You will want to do a very thorough evaluation of your financial statements before you commence your offering. The end game is to determine a bottom-line profitability from your P&L and SDE adjustment but that is not the only element of importance. Line item and grouping subtotals are also very important.
Here are some quality review suggestions to consider:
Revenue
A single line is never good unless you only offer one product a service. There should be an informatively captioned line for each type of product or service offered.
Cost of Sales
This is not a dumping ground for all labor except the owner’s compensation. This category is a cost of conduct (direct labor and direct materials) required to create a saleable product or service.
Gross Margin
Gross Margin is the amount your company earns after properly recognizing the revenue earned less the direct cost of labor and materials needed to achieve that revenue. This gross margin percentage is critically important for a buyer to assess the financial performance of your company. A company with a 40% gross margin is very impressive compared to a company with a 20% gross margin.
Selling, General & Administrative (SG&A)
SG&A is also referred to as overhead or indirect costs of doing business. These expenses include rent, insurance, office expenses, indirect labor costs, marketing, sales etc. Costs that are required to operate the business but are not directly involved with the products or services being sold.
Buyers look at direct expenses very differently than indirect expenses. Direct expenses are viewed as essential to operate the business. They are evaluated to determine if they are effectively managed or if they anticipate labor or materials savings or cost increases post-acquisition
Indirect expenses are usually viewed negatively with a slant towards what expenses can be eliminated (or saved [synergy savings] upon business combination).
In an effective offering all personal, one time and redundant expenses should have already been adjusted for.
Buyers can anticipate savings. Example, I just had a plumbing company that was paying 40,000 a year for liability insurance. The buyer anticipated that due to their scope and scale they could secure the same coverages for 6,000. The seller was not doing anything wrong but the buyer was able to carve out a future opportunity.
Point of Clarification – buyers do not give the sellers credit (SDE Adjustment) for future synergy savings.
A key requirement of P&Ls is that the line-item captions should be correct and consistent throughout the reporting periods being shared. Hopefully, you have not played the financial game of charging expenses to where there is available budget. That destroys the credibility of the financial presentation.
If you have changed your chart of accounts, notify your M&A advisor immediately. These changes create reporting disparities over the periods being reported and that creates a lot of variances. The variances are mathematical variances and not economic variances. Example. If 6,000 a month of lawn care was charged (coded) to miscellaneous for 18 months and then in the new landscaping account for 18 months, the overall expense amount was the same for all 36 months. However, it reports out poorly on a line item by line-item basis.
You want absolutely as much consistency as possible and you need to get out in front on explaining inconsistencies. I always advise full disclosure and to get out in front and stay there on information sharing. It is optimal to inform before the buyer detects. That will save you a lot of wasted time and effort.
It is always advisable to include a percentage column next to each year-to-date column. This shows you are declaring your gross margin, SG&A and Operating Income percentages clearly and upfront.
If you really want to get way out in front (internally) here is an amazing technique.
Put your 36 monthly columns (and YTD columns for each year) in an Excel spreadsheet. Save it with a new file name and then covert all dollar amounts into percentages. You will be shocked what pops off the page at you. Scanning across each row you will see something like an expense that was between 3% and 5% for 35 of the 36 months and then 8% for one month. This is called exception tracking and analysis. Now you have identified your exceptions in advance and you are prepared to be conversant (not defensive) on them.
Do NOT share this percentage P&L with the buyer unless there are none or only a few significant variations that require explaining. Otherwise, this is your behind-the-scenes cheat sheet to ensure that you are knowledgeable and can fully explain any buyer inquiries.
The end game is a confident, complete presentation style so that you earn the respect of the buyer.