What do you “run” through your business?

We all want to pay less tax, right? So it figures that we take every opportunity possible to run expenses through our business. But be warned: if you’re not careful, this can end up costing you way way more money than you ever saved in tax.

Recasting financial statements, the pros and cons…

How?

Just think about what happens when the time comes to sell. In the same way that it’s a no brainer that you want to pay as little tax as possible during the course of your day-to-day business, you’ll want to sell your business for the highest possible sum. That’s a given. But what if you’ve spent years running expenses through your company that might not be fundamental to the business once someone else takes over? In one fell swoop, you may have devalued your company.

Let’s say for argument’s sake you submitted your numbers to the IRS and declared an annual profit of $300,000, and let’s again say for argument’s sake that a buyer comes out of the woodwork and makes you an offer of $1.2m, based on a x4 multiple of that figure. Would you be willing to shake hands on that figure knowing that your profits from last year would have been higher had you not offset them against that country retreat you bought (plus a load of shiny new jeeps to go with it) for the purposes of “entertaining”?

Had those expenses not gone through the company, your profits could have been upwards of $500,000, which at a x4 multiple could have induced an offer of $2m +. All hypotheticals of course, but the point is: you should be thinking about how your business comes across to EVERYONE – not just the tax man. The point certainly is NOT that you shouldn’t have put through that country retreat or whatever your own equivalent might be; it’s just simply that you need to properly manage the situation once you do.

Recasting financials

The good news is, you can have the best of both worlds. You can run your business in a way that saves on your personal tax liability, but when the time comes, you are still able to sell it for its ’true’ value. Recasting financials, in short, is the process that makes this happen. By the end of it, you will have a set of figures that show the genuine profitability of the business in the long term, and that might well mean the removal of certain expenses.

Just to re-iterate the point, I am not telling you to automatically change your thinking about what constitutes an ‘expense’ and what doesn’t. In fact, just to take my own former company as an example, my Dad and I would expense our annual South Dakota hunting trip to the tune of $15,000 per year. We would have a great time – it was a kinda holiday – but we’d invite 10-15 of our clients to join us. For the IRS, this was a legitimate sum to be removed from the bottom line, but when it came to sell, it was equally legitimate to show a higher profit sum that wasn’t affected by this figure.

Strengthen your poker hand

Beyond the simple maths of a higher profit equalling a higher valuation, let’s consider the human side of all this for a moment. Any deal between two parties is based on a certain amount of trust, and a surefire way to gain trust is to have a set of recast financials that lay everything bare. In the above example we explained everything – we showed exactly how we arrived at our profit/valuation of the company and how this was different to the figures we submitted to the IRS.

Also, by being pro-active in this way, you put yourself on the front foot. The last thing you want is somebody coming to you who deems your company info to be vague, inaccurate or dodgy in some way. That’s when the fine-tooth comb comes out, and once that happens, it can all unravel.

I remember working with a client who offset something like $2.5m worth of profits against their company jet. In itself, this was not a crime – the legitimacy of it was technically arguable – but it put up this giant red flag which caused other aspects of their business to be investigated, and before you know it: armageddon. A collapsed deal, criminal charges, the works.

So just be aware of what can happen, and that there are wider ramifications to expenses than just simply “how much tax will this save me?”. Just like if you’re in a relationship… once you see something dodgy about someone, you look for more negative things in their personality. We’ve all been there.

The facts of the matter

Did you know that 9 out of 10 business takeovers fail at the due diligence stage? Did you also know that most offers to buy are made out of the blue, when a business isn’t even on the market?

So there is every incentive to get your story straight and to always keep a hold of what the current value of your business is. Don’t just be content with submitting your accounts every year and being judged purely on those figures.

My advice…

To make sure your house is in order, get a proper accountant and/or a good CFO. But that’s just for starters. You have to make damn sure that you manage them properly. It is not enough to just leave someone else to deal with the figures and assume that the job is done. Consider their role as one that deals with the day-to-day, does the donkey work, and provides guidance for the top-level strategy – a top-level strategy that you are ultimately responsible for.

When thinking strategically about matters of financial reporting, always make sure you consider the simple phrase “what if someone wanted to buy this company tomorrow… can I prove how much I think it’s actually worth?”. If you do that, you won’t go far wrong. Not only will that ensure you always understand the value of your day-to-day activity, it will guarantee that you’re ready for the best possible exit.