If you’ve been reading this 30 Days to ETA series, you know that in the Day #11 post I discussed how your ETA Entity Formation is an important structural item on your journey to Entrepreneurship Through Acquisition (You can read the previous post by CLICKING HERE). In today’s 30 Days to ETA post, as an Accountant I want to look at two of my favorite things in the business world – facts and figures in the form of ETA Metrics/KPIs. We’re going to deal with the financial reports your future business needs to provide to not only lead the organization successfully, but allow interested buyers to see how great a business you have. Remember our end-game when it comes to Acquisition Entrepreneurship, that in order to make a business sellable we have to provide buyers with accurate financial reports that show our historical growth, our current financial status, and our business’s potential growth in the future…. Enjoy!
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Fact and Figures Drive Success
In our Mergers & Acquisitions business at Tip of the Spear Ventures, we’re often asked how ETA Metrics/KPIs can allow you to identify/acquire the perfect business. While perfection might be elusive, finding a nice business shouldn’t be if you stick to our ETA Metrics/KPIs formula. At Tip of the Spear Ventures, this method has yielded unbelievable success. The ETA Metrics/KPIs method will also not turn away potential buyers when it comes time to sell your business because a buyer can’t take figures scribbled on a napkin to the bank. Key Performance Indicators (KPIs) should tell a story of the business, regardless of formal system utilized and say, “Is this a viable business for me to buy? Is this business going to be profitable for me a couple of years from now?” Ironic right? These are the same questions you’ll ask when looking to conduct your mergers & acquisitions search for the right business to purchase!
Liars might figure, but figures never lie!Sam Palazzolo, Managing Director @ Tip of the Spear Ventures
Show Growth + Current Status with ETA Metrics/KPIs
So what types of financial reports show buyers and banks the health and wealth of your business? Or how do you personally figure out how well your company is doing at any given time?
This is where our business management systems come into play. You’ll need to have a basic financial management system in place that allows you to compile facts and figures on a daily basis. Whether you use QuickBooks, Quicken, Sage, Microsoft Excel Spreadsheets, or an outsourced bookkeeper/accounting firm, the accounting system you use needs to be able to compile at least two different financial reports – The Balance Sheet and Operating Statement
1. The Balance Sheet
Your CPA has most likely asked you to print your company’s balance sheet at the end of each year so that they can begin preparing your taxes. But what does it show? Very simply, the balance sheet tracks your company’s assets and liabilities. It provides banks, buyers, or tax advisers a picture of what you own and what you owe.
In detail, the balance sheet provides the following information about your company:
- Net worth – Accomplished by subtracting your liabilities from your assets.
- Debt to income ratio – Calculated by looking at the amount of money you’ve borrowed compared to the assets that can be used to pay off that debt.
- Cash equivalency – A quick ratio test can show how much cash your company has coming in to offset its upcoming expenses.
- Collection periods – A collection test can calculate how long it takes your company’s accounts receivables to turn into cash collections.
2. The Operating Statement
Inevitably, your company will have to produce an operating statement for lenders, buyers, and CPAs in addition to a balance sheet upon the sale of your company. You may recognize this financial report by its more common name, the Profit and Loss statement, or the P&L. While the balance sheet details your company’s assets and liabilities, the operating statement details your company’s income and expenses. Think long-term figures for the balance sheet versus short-term figures for the P&L.
In detail, the operating statement can provide the following information about your company:
- Profitability – Derived from the profit margin ratio comparing the net profits (income earned after expenses but before taxes) to your gross sales income. E.g. – If you sell $1,000 in a month with a net income of $100, your profitability is 10%.
- Return on Investment – Calculated ratio that compares the net profit of your company to your company’s net worth. E.g. – If your company’s net worth is $1,000,000, and it’s earning $100,000, your return on investment is 10%.
- Inventory Valuation – Technically, the value of your inventory is how much you paid for it. To determine if you have too little or too much inventory at any given time, you need to figure up an end-inventory value ratio. E.g. – If you paid $100,000 for your current inventory, and your monthly sales are $50,000, you have a 2:1 ratio. In other words, your inventory is two times greater than your sales.
The Importance of KPIs
While a financial management software or company can easily compile a Balance Sheet or an Operating Statement from your company’s bank ledgers and bills, you, as a business owner, will have to compile the last type of financial reports a potential buyer will need.
You will have to identify the Key Performance Indicators, or KPIs, that show how successful your business is currently and how successful it can be in the future. Once identified, you will then use the indicators to analyze and predict future income and expenses in a quantifiable financial report.
The difficult part of KPIs is that every business has different performance indicators. For example, dentists can predict income by pointing to the number of patients scheduled each week or the number of patients pre-scheduled for the upcoming year. KPIs aren’t just important for tracking income. They identify upcoming expenses, growth pains, risks, rewards, and opportunities. Essentially, KPIs paint a picture of the strengths and weaknesses of your business.
KPI Financial Reports – Now What?
Once you predict your future income and expenses, your company’s strengths and weaknesses will show up. Obviously, you’re going to know what you like about your company and what you don’t like about your company. That’s what your buyer is looking for, too. He’s going to hire attorneys, CPAs, and people like me to tear your business apart to find its strengths and weaknesses. So you might as well use your KPIs to analyze your business before they do. Here’s what you can do:
- Consult with your advisers to identify what data a buyer needs to see.
- Create a system that produces, compiles, arranges, and presents that data in financial reports.
- Analyze the financial reports from a buyer’s perspective.
- Make the necessary changes to your business.
So we’ve identified the compilations of ETA Metrics/KPIs and financial reports you will want to see when you’re interested in purchasing a company. By having quantifiable, printable financial reports that show your company’s historical growth, current success, and future potential, you’re probably going to have increased confidence as you pursue your Entrepreneurship Through Acquisition strategy.
Before buying your company, though, you can use their Balance Sheet, Profit and Loss Statement, and KPIs to get a better grasp on the business. You can use those financial reports to compare the company’s strengths and to identify their weaknesses. If you start doing that now, your ETA business’s value is going to shoot through the roof. You might be able to sell your company earlier than you expected, or you could sit back and reap the rewards of your hard work before you reach sale time (You may also save yourself significant time with a business that you shouldn’t purchase in the first place!)