For an SME business, management accounts are often overlooked because they are seen as unnecessary, expensive and difficult to produce. That may very well be true in the day-to-day running of the business, after all, you have other ways to keep track of performance, such as cash in the bank or monitoring project profitability. But when it comes to selling your business, management accounts can become an extremely useful tool, here’s why…
Surplus cash is defined as the amount of cash in the business over and above the amount of cash the business needs to function on a day-to-day basis. Most businesses will have some surplus cash and some will have significant cash reserves. Surplus cash can be useful in normal business operations for paying down debt or investing, but in the world of M&A, surplus cash has other benefits. The expectation for most company sale deals is that they are done on a cash-free, debt-free basis. So, the wonderful thing about surplus cash is that it can usually be extracted from the business tax-efficiently as part of the sale proceeds.
However, the challenge is determining what proportion of the cash in the business is required for working capital and what proportion is, therefore, surplus. This is usually subject to some scrutiny and negotiation during the due diligence phase of a sale. The starting place for this, as the exiting shareholder, is to demonstrate the normal operating cash demands of the business, which is where management accounts come in.
While annual accounts do a good job of showing the cash position at a single point in the year, they don’t demonstrate the natural ebb and flow that most businesses experience throughout the year, especially if the business is particularly seasonal. Additionally, they can be up to 9 months old by the time they are published, whereas management accounts are typically produced within a week or two of the month end.
So there are two crucial things that a set of management accounts will allow you to do:
Demonstrate a normalised cash flow for the business to facilitate the calculation of surplus cash. You need at least 6 months, but ideally 12 months, of management accounts to do this satisfactorily. This will leave very little room for negotiation or doubt when it comes to determining this cash figure.
Acquirers will often ask for up-to-date financials so they can assess the latest position of the company. This is because statutory figures may well be 12 months or more out of date. Having up-to-date management accounts solves this issue, as well as allowing the acquirer to assess trends by seeing results over a longer period.
EOT or other types of funded sale
Employee Ownership Trusts are an increasingly popular option for shareholders looking to exit their business or realise some value from their business asset, the most recent figures suggest more than 1,300 businesses in the UK are now employee-owned. See our EOT blog here.
However, the way shareholders are paid out on these deals is with the majority of the consideration coming out of the proceeds of the business over the next few years. It is, therefore, essential that the business can demonstrate the affordability of these payments, which is where management accounts come in.
There are also other ways of funding an acquisition where good management account information will be extremely useful.
Of course, none of this changes the fact that producing management accounts can be costly and time-consuming. But inevitably, it is easier to produce them in real-time than retrospectively, and they will make the due diligence process a lot easier and quicker. In conclusion then, while we wouldn’t necessarily recommend producing management accounts as a matter of course, we would recommend getting into the habit at least six months to a year ahead of selling, or re-financing the business.