What happens when a buyer's accountant opens your books

There is a moment in most deals when the mood changes. An offer is agreed, everyone is pleased, and then a buyer’s accountant asks for three years of financials and a general ledger.

What happens next decides more transactions than the negotiation did.

What they are actually doing

Not looking for fraud. Almost nobody finds fraud. They are doing something narrower and harder to survive: confirming that the earnings figure in the offer is the earnings figure the business produces.

Every number in that calculation has to trace back to something. Revenue traces to invoices and deposits. Expenses trace to bills and payments. Add-backs, the owner expenses a new owner would not incur, trace to specific transactions with specific documentation.

Where a number does not trace, it does not count. That is the whole mechanism. An accountant does not have to prove a figure is wrong to remove it. They only have to be unable to prove it is right, and the burden sits with the seller.

The order they work in

Revenue first. They will tie reported revenue to bank deposits, usually month by month for two or three years. This is where cash-basis businesses with informal record-keeping run into trouble, not because revenue is overstated but because the tie-out does not work cleanly and every unexplained gap becomes a question.

Then owner compensation and benefits. What you pay yourself, what the business pays for on your behalf, and whether a new owner would incur the same cost. A market-rate salary for the role you actually perform stays as an expense. The excess above it is an add-back, if you can show it.

Then the personal expenses. Vehicles, travel, phones, meals, family members on payroll, the boat. All legitimately add-backable, all requiring documentation. This is where the largest single reduction usually happens, and it is entirely a record-keeping problem rather than a business problem.

Then working capital. What the business needs in receivables, inventory and payables to operate at its current level. Buyers expect the business delivered with normal working capital in place, and disagreements here surface late and cost real money.

Then the one-offs. A legal settlement, a bad year, a piece of equipment bought outright. Genuine one-offs come out of the earnings calculation, which usually helps the seller. They still need evidence.

The finding that comes up most

Books kept on a cash basis, in accounting software, never reviewed by an outside accountant.

That describes an enormous number of profitable small businesses, and it is not a criticism of how they are run. It is a description of a problem that only becomes a problem at one specific moment. A buyer’s accountant looking at unreviewed cash-basis books has no independent confirmation of anything, so they discount for uncertainty, or they ask for a quality of earnings review at the seller’s cost, or they restructure the deal to shift the risk back to the seller through an earn-out.

None of those outcomes is the number the seller was expecting.

What actually fixes it

Get an outside accountant involved, and do it a year early. Not to find problems. To be the person who can say the numbers were reviewed. That statement is worth more in diligence than any individual adjustment.

Move to accrual if the business is big enough to warrant it. Accrual accounting matches revenue to the period it was earned, which is how a buyer thinks about earnings anyway. If that is a large change, at minimum get a reviewed cash-basis set with a clear reconciliation.

Tag owner expenses to the transaction level, starting now. Not reconstructed later from memory and credit card statements. Tagged as they happen, with a note. Twelve months of properly tagged owner expenses is worth more than three years of reconstructed ones, because the reconstructed version invites exactly the scrutiny you do not want.

Assemble the pack before anyone asks. Three years of financials, three years of tax returns, the general ledger, a receivables ageing, a payables ageing, an equipment list, the lease, the top customer contracts. Put it in one place. When a diligence request arrives with a deadline, the difference between producing this in a day and producing it in a month is not administrative. A slow response reads as a red flag whether or not it is one.

Why this is the cheapest item on the list

Owner dependence takes eighteen months and a change in how you work. Customer concentration takes a sales cycle. Personal readiness takes as long as it takes.

Accounting cleanup takes a quarter and some money, and it moves the earnings figure that everything else gets multiplied against. Of everything an owner can do in the year before a sale, this has the best ratio of effort to effect, which is why it is odd how often it gets left until a buyer forces it.

Where you stand

Three of the eighteen questions on the Exit Readiness Score cover this ground: how your books are kept, whether you could produce three years of clean statements inside a week, and whether personal expenses are identifiable. It takes about five minutes and asks for no figures.

The related piece on add-backs goes into which owner expenses survive diligence and which never do.