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Don't Steal From Yourself When Selling Your Business
One of the biggest mistakes business owners make in the sale of their business can start years before they decide to sell. It’s slipping into a cash economy. You may think that taking cash from a customer or client and never declaring it is one way to minimise your tax, but in the end, you may be stealing money from your own pocket.
In the short-term, that’s a false economy, as your tax bill will be much higher if the government levies fines after you’re caught. But it’s an even larger long-term error if you’re planning on selling your business. Not only will undeclared earnings lower the value of your business, but they could also jeopardise your ability to sell at all.
Most businesses are valued on earnings before interest, taxes, depreciation and amortisation, or EBITDA. A multiplier is applied to the EBITDA to give the value of the business. Therefore, maximising the profits you have on the books is critical in getting the best outcome.
The key here is "on the books." No potential buyer is going to accept your word that there’s plenty of cash you haven’t declared, and that it should be included in the valuation. You need to prove the income is there, and if you haven’t reported it, there’s no way to show that proof.
If you assume a multiplier of four when valuing your business, this means every undeclared dollar is costing you $4 when it comes time to sell. It probably only saved you 30 cents in taxes. EBITDA is based on before-tax earnings, so if you had paid those taxes, they would have been added back into the valuation.
Using Cash for Expenses
Business owners operating in the cash economy often don’t realise the money they don’t record is also paying for expenses that aren't properly recorded. This means payroll and supply expenses aren't accurately reflected on any financial records.
If a buyer is willing to make an offer based on your reported profits without the cash payments, they may think twice if they realise your reported expenses are inaccurate. This often comes out during due diligence when the buyer realises, for example, that your cafe isn’t paying anyone to bake the cakes and questions where those expenses have been listed.
The buyer may choose to continue with the sale, but the offer price will go down based on the new expense estimates.
In Australia, the cash economy is estimated to cost $15 billion in lost federal tax revenue. It’s understandable that tax departments are looking closely at industries known for operating on a cash basis. Even in an industry that’s not traditionally cash-based, the tax office can discover undeclared profits by comparing what you should be earning with what you’re declaring.
Buyers are generally risk-averse. They want a business that will make regular profits without too much stress. If a buyer realises you have undeclared income, they may choose to walk away from a sale rather than risk a tax audit that goes badly and leads to fines against the business.
It may seem like not declaring your income is an easy way to keep a little more money in your pocket, but if you're ever planning to sell your business, it can be one of the worst mistakes you make. Declaring all your income to the tax department allows you to base the value of your business on all your income, leading to a higher price when it comes time to sell.