If your business is about to dive into a quality of earnings, there are steps you can take to maximize the value and have a smooth process. What are they? Find out in this PKF Texas – The Entrepreneur’s Playbook® episode, featuring Audit and Transaction Advisory Director, Chris Hatten, CPA, CVA, CM&AA.
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Jen: This is the PKF Texas – Entrepreneur’s Playbook®. I’m Jen Lemanski, and I’m back again with Chris Hatten, a Director on our Transaction Advisory Team, as well as one of our Approachable Advisors™. Chris, welcome back to the Playbook.
Chris: Appreciate it.
Investing in an Accounting Function
Jen: So, we’ve talked about quality of earnings (Q of E) a number of times on these videos, and before a business decides to sell or go through the Q of E process, sell-side Q of E process, are there steps that they can take to maximize the value when they’re doing this?
Chris: There are. And the first one being: I would probably say investing in your accounting function. And so, when I say “accounting function,” I’m not only talking about your controller, your CFO, but on the technical side, your accounting system. You might have a company business that has gone from 30 to 300 million dollars. And those are great stories, but your company bookkeeper who was with you originally, you might outgrow them.
And so, you’ve got to think about, do I need to be investing in a true CFO-type person? Do they need additional assistance down below them? Maybe they’re technically ready to take on new roles, but do they need support then? You’ve always heard the adage, bad information in equals bad information out. So, that’s what you want to avoid because these are the decisions that are helping you determine the trajectory of your business.
So, I always say, don’t skimp in this area. One area that we’ve seen grow a lot and that we actually do here at the firm is fractional, whether it’s controller or CFO work. And so, you might not need a full-time CFO but maybe the fractional route might be something to think about.
From the technology side of things, QuickBooks is great. We have a lot of clients that are on QuickBooks, but if you’re growing, you need to think about, is it time to invest into that next system? We’ve seen a lot of companies that have not made those investments over the years, and now they’re in systems where it’s going to be especially painful to migrate to a more robust system.
And not only for your current operations, you want to be able to have this aggregated data to help you make a more informed decision hopefully. But then also as a transaction comes down pipe, they’re going to be asking for a lot of information and you won’t be able to slice and dice your information and get it.
Jen: Here you go.
Chris: Yeah exactly. But again, we’re talking about pre-transaction, so you just want to make sure that you’re investing in your company and your business so that you can help it in the here and now, which is then going to pay dividends down the road.
The Budgeting Process
I would say the next one would probably be the budgeting process. Surprisingly, we still have some clients that we ask, “Hey, do you have a budget because we want to see how you did against the budget.” And there’s still some businesses that don’t do that. And it would be a little surprising because I bet if you go home, they’ve got a home budget that they live to.
Jen: Car, mortgage, et cetera. Yeah.
Chris: All that kind of stuff. And so, we would say get that implemented right away because you want to see how you’re progressing against your goals. If you’re having a good year, a bad year, what may have driven a dip in a certain month. But then also on a goal forward basis, if you’re thinking about making some of those capital expenditures, then this piece of equipment X Y Z is going to cost three million dollars.
So, how much is that going to drive sales? How much in additional labor could you potentially have to hire? And so, all those different things are going to help you say, “Hey, can I afford this piece of equipment?” or, “We need to buy this piece of equipment, but then also this is what’s going to go along with it.” You don’t just buy your vacation and say this is what’s going to be at. You know that there’s going to be the dinners and everything else that goes along with it that adds on, so that can help in that process.
A Financial Statement Audit
And maybe the third point, and I’m not using this to sell additional work, but would be a financial statement audit. There’s a lot of value that actually comes out from a financial statement audit. Most people think it’s just a compliance tool, if nothing else, you know that you’re getting your numbers on a GAAP basis at least one time per year.
And if you’re having a bunch of adjustments that come out because of your audit, a lot of times there’s also going to be what we call a management communication letter that goes along with that because if we’re posting an adjustment, then maybe somewhere along the way there’s an internal control that is either missing or not working. And so, then you’re going to have this management communication letter that you can use to help shore up your internal controls.
But then also if there’s journal injuries that are being posted, you can say, hey, is this something that is just routinely going to be part of our year end closing process or is this something that the controller needs to bake into their monthly closing process so that we have more accurate financial statements throughout the year.
Because again, if you’re waiting until year end and you’re having these huge adjustments, you think you might be doing great and then all of a sudden, I hate to say you get kicked in the teeth at year end because they weren’t booking certain accruals and all that. And then what looked to be a pretty solid year is still good, but just not as great as it as it could have been. And again, from a transactional side everybody likes having an audited financial statement, so.
Jen: The banks are going to ask for it, the PE firms are going to ask for it, everybody’s going to ask for it.
Chris: Exactly. And so, if you’ve got that and then you’ve been using those other intangibles along the way, I think it’s going to help set you up for a smoother process going forward. So again, just capping it at three. I think that those are three easy ones that maybe don’t give a lot of credence to, but I think we’ll pay off dearly once you get a deal done.
Jen: Perfect. Sounds good. Well, we’ll get you back to talk about some more transaction-related things. Sound good?
Chris: We can do that.
Jen: All right. This has been a thought leadership production brought to you by PKF Texas – The Entrepreneur’s Playbook®. For more information about this and other topics, visit www.PKFTexas.com. Tune in next week for another chapter.