Question 1

Why do financials matter so much in a business sale?

Accepted Answer

Your business is being valued based on its earnings. If the earnings aren't clearly documented and verifiable, buyers discount them. Undocumented SDE becomes negotiated SDE — and buyers always negotiate down. Clean financials with clear add-back documentation consistently produce 10–20% higher sale prices than comparable businesses with messy books.

Question 2

What's the difference between cash-basis and accrual-basis accounting?

Accepted Answer

Cash-basis records revenue when received and expenses when paid. Accrual-basis records revenue when earned and expenses when incurred. Buyers (especially PE) prefer accrual-basis because it gives a more accurate picture of the business's financial health. If you're on cash-basis, consider switching to accrual in the 12 months before going to market — or have your CPA prepare accrual-adjusted statements.

Question 3

What's a 'recast' P&L and why do I need one?

Accepted Answer

A recast P&L (also called adjusted or normalized P&L) starts with your actual reported financials and then adds a column for adjustments: adding back owner salary, benefits, personal expenses, and non-recurring items to arrive at SDE. This document is the primary valuation basis for the entire deal. Buyers use it to calculate SDE and apply the multiple. Without it, you're leaving your valuation to the buyer's interpretation.

Question 4

How many years of financials do buyers want?

Accepted Answer

Standard request: 3 years of P&L and tax returns, plus current year-to-date. Some PE buyers request 5 years for larger transactions. The most recent 12–24 months get the most scrutiny because they reflect current performance. Trailing 12 months is often weighted most heavily in the SDE calculation.

Question 5

Do my tax returns and P&L need to match exactly?

Accepted Answer

They should be reconcilable — not necessarily identical line-by-line, but a buyer's accountant should be able to trace from one to the other. Common acceptable differences: timing differences (cash vs. accrual), depreciation schedules, owner benefit items. Unexplained gaps between tax return income and P&L income create serious buyer concern.

Question 6

What are the most common financial red flags buyers see?

Accepted Answer

Red flags: large, unexplained revenue drops in a specific year, revenue that varies wildly year-to-year without explanation, personal expenses commingled with business expenses without documentation, significant related-party transactions (paying family members without clear business purpose), revenue or expenses that appear manipulated, and discrepancies between bank statements and reported revenue.

Question 7

Should I use a CPA who specializes in M&A for sale preparation?

Accepted Answer

Yes — strongly recommended. A general business CPA can keep your books; an M&A-experienced CPA knows how to prepare a recast P&L, properly document add-backs, and structure your financials to withstand QoE scrutiny. The cost is $2K–$10K for the prep work; the benefit is often $100K–$300K in additional sale proceeds because the SDE calculation holds up.

Question 8

How do I handle a year with unusually high or low revenue?

Accepted Answer

Explain it in writing. Every unusual year needs a clear explanation: COVID-19 impact, weather events (roof damage driving windfall revenue), one-time commercial contract, lost key employee. Buyers need context to normalize the SDE. A spike year without explanation raises questions; a spike year with a documented, logical explanation is acceptable.

Question 9

How do I clean up owner add-backs before going to market?

Accepted Answer

Work with your CPA to: (1) identify all personal expenses run through the business, (2) document each with an explanation (e.g., 'personal vehicle — used 80% for business, 20% personal'), (3) calculate the total documented add-back amount, (4) prepare supporting documentation (receipts, insurance bills, subscription statements). Every dollar of add-back without documentation is a dollar buyers will question.

Question 10

What happens if my financials don't hold up during due diligence?

Accepted Answer

If financial representations turn out to be inaccurate during diligence, buyers will either re-trade the price (reduce it proportionally), add indemnification provisions protecting them post-close, require a larger escrow holdback, or terminate the deal entirely. Surprises in diligence are the leading cause of deal failure. Prepare to the point where there are no surprises.

Question 11

Should I get an audit or a review before going to market?

Accepted Answer

Most home service businesses don't need a full audit ($15K–$50K). A compilation or review ($2K–$8K) from a CPA adds credibility to your financials and can accelerate buyer confidence. Alternatively, some sellers commission a sell-side Quality of Earnings report ($15K–$30K) — this is overkill for most businesses under $3M but valuable for businesses approaching PE buyer territory.

Question 12

How do I handle unreported cash income?

Accepted Answer

Don't attempt to include undocumented cash income in your SDE. Buyers can't verify it, lenders won't accept it, and claiming income not on your tax returns creates legal exposure. If you have cash income you haven't reported, consult a tax attorney before going to market. The sale preparation process sometimes motivates owners to get their books compliant — do this well before listing.

Financial Preparation for Sale: 12 Questions Answered

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