One of the most important components of a successful M&A process is the way in which sellers present their financial information to potential buyers. The typical financial statements or tax returns of privately held companies are generally not suitable for a promising M&A strategy. Owners of private companies tend to focus more on minimizing tax liabilities rather than maximizing business valuation. In order to properly depict the true financial capability of the business, owners must consider recasting their financial statements.

The intent of recasting is to make adjustments to the financial statements to demonstrate the operating potential of the firm in normal conditions to a potential buyer. Some of the adjustments may benefit the seller while others may benefit the buyer. In either case it provides a better understanding of the business to all parties involved. There are many items that qualify for recasting that apply to the Income Statement or the Balance Sheet. Below is a list of potential items that should be considered:

  • Owners compensation is discretionary; if exceedingly high or low, it should be recast to reflect the rate at which another individual would be paid to perform the same task.

  • Executive perks, which may include luxury cars, club membership, or first-class travel should be recast to align with customary standards for fringe benefits.

  • Any extraordinary expense, such as legal/advisory fees, should be considered since it is a one-time expense.

  • Travel and entertainment is a necessary expense in operating a business, however, family vacations to Hawaii do not qualify even when a little business is mixed in while relaxing with family.

  • Undervalued or overvalued investments in securities or in real estate, or the like, should reflect its market value.

The list of items goes on and, at times, its easy to lose sight of the forest for the trees as the complexity of the task increases. However, being well prepared and prudently recasting your financial statements to provide acquirers with a cleaner, clearer picture of the financial situation going into negotiations will help lead to a successful M&A transaction.

A version of this article originally appeared in Soft•letter and Software Success.