Ignore the Balance Sheet at Your Own Risk

A number of years ago I worked with an investment group. The president was a very experienced and very good operator but somewhat new to the deal process. He told me something that’s stuck with me when he said how as an operator he was concerned with the profit and loss statement but as a deal person he found an appreciation for the balance sheet and its importance.

The balance sheet tends to get overlooked by many businesspeople, sellers, and buyers, which is a shame. The balance sheet is filled with information, some of which is:

  • How does the company manage its cash flow and what level of working capital is needed?
  • Does the company replace assets regularly?
  • Is the owner bleeding the company of cash for personal use?
  • How is inventory managed?
  • Are they using proper accounting techniques (easily noticeable when there’s work in process, they take deposits for future work, issue gift cards, etc.)?

I often look at the balance sheet before the income statement to see the above or more. Unfortunately, too many people just look at the bottom line, more get fascinated by EBITDA (and ignore capital expenditures), others believe what they see when it’s “adjusted” EBITDA (one recently included the salaries for three owners, all who are leaving the company when it sells).

In my industry too often buy-sell professionals ignore the balance sheet, and working capital (buying the job of owning a deli – no need for working capital, buying more sophisticated business – the deal should include normal working capital). I don’t know why. It could be a lack of understanding, it could be “if we don’t mention it then it will go away,” or perhaps there’s worry it opens up too many questions about the business and its current and future state.

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