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HOUSTON BUSINESS REVIEW
TUTORIAL ON SELLING YOUR BUSINESS "Enhancing Value – Financial Perspective Part III"
By Ralph Fain
Ralph Fain is a principal in the brokerage firm, R/Fain Group. Mr. Fain also has over 20 years of broad business experience with Fortune 500 companies. R/ Fain Group is a professional business brokerage firm which confidentially represents the interests of various sellers and buyers. Each week Mr. Fain will give tips on Business Brokering, and how to sell your business.
In our last article, we discussed the importance of accuracy, reliability and comparability of financial statements and the part variance analysis plays in ensuring same for your company. Today we will continue the discussion of variance analysis and also talk a little about “re-casting” of financials. As you may recall, variance analysis is, in its simplest form, a methodology which detects “out of the ordinary”/”out of line” numbers or figures in your financial statements. Consider our summary of financial statements from our earlier article:
2002 2003 2004
$ % $ % $ %
Sales/Revenues 1,000,000 100% 1,100,000 100% 1,200,000 100%
Cost of Goods Sold 570,000 57% 616,000 56% 860,000 72%
Gross Profit Margin 430,000 43% 484,000 44% 340,000 28%
Sales, General & Admin. 320,000 34% 352,000 32% 322,000 27%
Net Income 110,000 11% 132,000 12% 18,000 1%
We had determined that the 2004 figure for Cost of Goods Sold at 72% was too high (when compared to 2003 and 2002 results) and that SG&A (Sales, General & Admin expense) at 27% was too low (again when compared to 2003 and 2002 results). As you can readily see, basic variance analysis has highlighted a potential problem (or problems) which occurred in 2004 which require further research and investigation – depending on the results of the research, this may also (and quite probably will) require a restatement of the 2004 financial statement to accurately portray the results of the company for that year.
Researching the above, we find that a new accounting clerk had mistakenly expensed $150,000 of expenditures which should have been properly capitalized as assets – the correction of this error results in a $150,000 decrease to Cost of Goods Sold (and a corresponding $150,000 increase to Gross Profit Margin). [Note: For illustrative purposes, we are ignoring any effect on depreciation expense resulting from the above re-classification). In addition, we find that $50,000 in Admin salaries had been miscoded to Cost of Goods Sold when it should have been classified as SG&A expense. The correction of this results in a $50,000 decrease in COGS and a $50,000 increase to SG&A expense. The results of our research and subsequent reclassifications are shown below:
Adjustments for above
Original 2004 figures $150,000 $50,000 Restated 2004 figures
Sales/Revenues $1,200,000 100% $1,200,000 100%
Cost of Goods Sold 860,000 72% (150,000) (50,000) 660,000 55%
Gross Profit Margin 340,000 28% 150,000 50,000 540,000 45%
Sales, General & Admin. 322,000 27% 50,000 372,000 31%
Net Income 18,000 1% 150,000 -0- 168,000 14%
As you can see, the process of variance analysis had highlighted “out of line” figures which required research. Consequently $150,000 in incorrectly expensed items were reversed and properly reclassified as additions to fixed assets; additionally, $50,000 in expenses were properly re-classed as SG&A expense from COGS expense. The above adjustments and subsequent “re-casting” of the financials culminated in a much more favorable presentation of the financial results of the company as the 2004 results now portray a consistent and continued upward and increasing trend for all major categories (Sales, GPM, etc) of the Income Statement; in addition the correction of the accounting error resulted in a $150,000 increase to bottom line Net Income.
Another benefit of a more favorable presentation is the probability that the value of the company has now increased in the eyes of a prospective buyer as a result of the adjustments made due to the research precipitated by the variance analysis.
Our next article will continue this discussion of comparability and variance analysis as it pertains to industry averages and will also delve more deeply into the “re-casting” of financials. See you in this same space for the next article which will continue the series regarding improving the financial presentation of your company. As always, should you have any questions or require additional information please feel free to contact the R/ Fain Group at 832-646-0832 or via our web site.
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Ralph Fain Archive
- Buying a Franchise – Part 2 (March 2007, Issue No. 3, Thursday Edition)
- Buying a Franchise – Part 1 (March 2007, Issue No. 2, Thursday Edition)
- The 12 Step Process (August 2006, Issue No. 4, Thursday Edition)
- “More Fundamentals on Selling” – Non-Competes and Earn-outs (July 2006, Issue No. 2, Thursday Edition)
- “More Fundamentals on Selling” – Part III (June 2006, Issue No. 3, Thursday Edition)
- “More Fundamentals on Selling” – Part II (June 2006, Issue No. 1, Thursday Edition)
- “More Fundamentals on Selling” – Part I (May 2006, Issue No. 1, Thursday Edition)
- “Asset Purchase vs Stock Purchase” – Part II (February 2006, Issue No. 1, Thursday Edition)
- “Asset Purchase vs Stock Purchase” – Part I (January 2006, Issue No. 4, Thursday Edition)
- “Other Factors to Consider When Selling” – Part II (January 2006, Issue No. 4, Thursday Edition)
- “Other Factors to Consider When Selling” – Part I (January 2006, Issue No. 3, Thursday Edition)
- “Sale Structure – Stock Sale” Pros and Cons (January 2006, Issue No. 2, Thursday Edition)
- “Sale Structure – Asset Sale” Pros and Cons (December 2005, Issue No. 5, Thursday Edition)
- “Selecting A Business Broker” (December 2005, Issue No. 3, Thursday Edition)
- “Earnings and Multiples” Part IV (December 2005, Issue No. 1, Thursday Edition)
- “Earnings and Multiples” Part III (November 2005, Issue No. 4, Thursday Edition)
- Earnings and Multiples” Part II (October 2005, Issue No. 3, Thursday Edition)
- Earnings and Multiples” Part I (October 2005, Issue No. 2, Thursday Edition)
- “Valuation – What’s My Business Worth” Part II (September 2005, Issue No. 2, Thursday Edition)
- “Valuation – What’s My Business Worth” Part I (September 2005, Issue No. 1, Thursday Edition)
- Preparing Your Business for Sale/Enhancing Value – Summary (August 2005, Issue No. 3, Thursday Edition)
- "Enhancing Value – Financial Perspective Part VII" (August 2005, Issue No. 2, Thursday Edition)
- "Enhancing Value – Financial Perspective Part VI" (August 2005, Issue No. 1, Thursday Edition)
- "Enhancing Value – Financial Perspective Part V" (July 2005, Issue No. 4, Thursday Edition)
- "Enhancing Value – Financial Perspective Part IV" (July 2005, Issue No. 2, Thursday Edition)
- "Enhancing Value – Financial Perspective Part III" (July 2005, Issue No. 1, Thursday Edition)
- "Enhancing Value – Financial Perspective Part II" (June 2005, Issue No. 4, Thursday Edition)
- "Enhancing Value – Financial Perspective Part I" (June 2005, Issue No. 2, Thursday Edition)
- “Preparing Your Business For Sale – Part IV(B)” (May 2005, Issue No. 4, Thursday Edition)
- “Preparing Your Business For Sale – Part IV(A)” (May 2005, Issue No. 1, Thursday Edition)
- “Preparing Your Business For Sale – Part III” (April 2005, Issue No. 4, Thursday Edition)
- “Preparing Your Business For Sale – Part II” (April 2005, Issue No. 3, Thursday Edition)
- “Preparing Your Business For Sale” (April 2005, Issue No. 2, Thursday Edition)
- Tutorial on Selling Your Business “Why Am I Selling”? (March 2005, Issue No. 5, Thursday Edition)
- Why a Business Broker (March 2005, Issue No. 3, Thursday Edition)
- Buying and Selling Businesses (and Related Topics) (March 2005, Issue No. 2, Thursday Edition)
- Who Is Ralph Fain? (March 2005, Issue No. 1, Thursday Edition)
- Utilizing A Broker, Benefits To Seller (February 2005, Issue No. 4, Thursday Edition)
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