Being a business owner can provide an owner the opportunity to meet interesting people, many owners of other businesses as well. Some of these owners may become customers. From time to time, the owner then becomes a customer of his customer, an arrangement good for both businesses. However, when this occurs there is the temptation to trade products rather than follow normal billing practices and exchange of payment. This practice is typically not in an owner’s best interest for several reasons.
First, these “trades” can throw off margins and ratios on the balance sheet. Since the expenses to build the traded product are in the cost of goods sold, but the revenues are unrecorded, it would appear the business is not operating efficiently.
There are also a number of businesses that sell for a multiple of revenues. If the traded products are not recorded as sales, the value of the business will be artificially lowered.
These examples also apply to cash sales. An owner may believe they are saving a few dollars in taxes (a fraction of the net profit), but they are giving up a multiple of the gross revenues in business value since the profits of the business are off by the entire amount of the unrecorded sale. Consider this example:
If an owner takes and does not report $100,000 in revenues, and this reduces net income by the same amount, the owner is saving $40,000 per year in taxes (assuming a 40% federal and state combined tax rate.) Thus over five years, the owner saves $200,000 in taxes. However, if this same income was reported for five years, and the business sells for a six multiple of earnings, the owner is leaving $600,000 ($100,000 x 6) in value on the table.
Additionally, if a business owner takes cash, and does not report the transaction, it influences the buyer’s perception of the owner’s veracity, the business’ profitability and the value of the business.
To go one step further, the investor does not want to hear about cash dealings, the bank does not want to hear about cash dealings and as an advisor, reputable firms such as Beacon Equity Advisors do not want to hear about them either.
Report your business transactions accurately in the normal course of business; it is safer and can significantly enhance value.