Accounting Tips For You

Creative Accounting Short-Circuits Business Sale

Recently I received a phone call from a man who wanted to sell his business.�We began to talk, and early in the conversation, I detected holes in his story.�

�

In a nutshell, here is what he shared:

�

His company’s current inventory had a retail sales value of $4 million. The markup on product cost averaged 100% (if it cost $1 it would sell for $2).��As the conversation continued he stated that the cost of his inventory on hand was $800,000.�The recent calendar year reflected sales of $1,000,000.�

�

When I received his corporate income tax returns, I saw that in fact, the company reported approximately $1,000,000 in sales with a cost of sales amounting $500,000.�Seems good so far, right?

�

I asked about the $4 million in “retail” sales value and the owner began to tread water.�He said that in reality, the company had purposely understated inventory costs at year end to save income taxes.�This comment muddied the water even further. Why?

�

If in fact, the company sells merchandise costing $1 for $2 then the $1 million in sales with half a million in cost would seem correct.�But, the tax return balance sheet reflected a cost of remaining inventory at year end of only $800,000.�At a 100% markup, the approximate retail value of inventory would be $1,600,000 and not $4,000,000.�Was the owner exaggerating the retail sales value ($4 million) of inventory?

�

The owner then stated that the “real” cost of inventory on hand was really closer to $2 million.�That statement drew even more doubt.�Was a substantial portion of the inventory obsolete?�The response was “no.”�Why did I ask?�If the markup is truly 100% of cost, then why were sales during the prior year only $1 million?�And, moreover, why would the company need $2 million of inventory on hand to support only $1 million in sales?

�

Had the company been under reporting sales?�Or, was the profit margin on sales much lower?�Clearly, there were many questions the business owner was not willing (or couldn’t) answer.

�

As a business intermediary, I look at a seller’s business in the same manner that a potential buyer looks at the business: with a healthy dose of scrutiny.�If there are obvious problems that will keep your business from selling, why would any business intermediary want to represent you?���

�

In the above instance I did not accept the engagement to sell the company.�I think the owner had played so many games with the books to “save taxes” that he had lost all sense of what he really had.�

�

My suggestion to business owners is to be honest with themselves (and the government).�Learn to look at your own business as a stranger would look at it.�If you were a stranger looking to buy your business, what questions would you ask?�Would the answers make sense to you?�Would the answers make sense to your CPA and your banker?�If not, there should be some serious housekeeping in your future.

If you are interested in valuing and/or selling your business, Grove has provided many additional short articles that can be found at http://www.gruttercpas.com

For professional and confidential guidance, call on Grover Rutter at 419-427-1564 or e mail him at grutter@gruttercpas.com