Financial Due Diligence Checklist for Business Sellers

Requests vary by deal size, but most buyers ask for these, roughly in this order:

• Financial statements: monthly and annual profit and loss statements, balance sheets and cash flow statements for the last three years, plus year-to-date.
• Tax returns: federal and state income tax returns, and sales tax filings for the same period.
• Revenue support: customer lists with revenue by customer, contracts for the largest accounts and a reconciliation of revenue to bank deposits.
• Balance sheet detail: accounts receivable and payable aging, inventory listings, fixed asset registers and a debt schedule.
• Payroll and headcount: employee census, contractor list and benefits.
• Adjusted earnings schedule: your add-backs, each with a document behind it.
• Working capital: monthly average levels of receivables, inventory and payables.
• Liabilities and commitments: leases, loans, pending claims and warranties.

Organize these in a folder structure that mirrors the list, the same way you would for a fundraising data room.

Many small businesses keep books on a cash basis for tax purposes, but buyers usually want accrual statements, because accrual matches revenue and costs to the period they belong to. Ask your CPA to prepare them, and expect these steps:

1. Record revenue when it's earned, not when the cash arrives, using invoices and contracts.
2. Record expenses when incurred, including bills received after month-end for that month's services.
3. Set up accounts receivable and accounts payable balances at each month-end.
4. Recognize prepaid expenses and deferred revenue, such as annual contracts paid upfront, over the period they cover.
5. Book accruals for payroll, bonuses, vacation and taxes.
6. Adjust inventory to actual counts and value.
7. Reconcile the result to your tax returns and explain the differences.

The work is easier when done monthly, so decide now whether to restate history or begin accrual closes going forward with a bridge for prior years.

Buyers reduce offers when they find things they can't explain. Check yours first:

• Financial statements that don't reconcile to tax returns and bank deposits.
• Personal and business expenses mixed together without a clear schedule.
• Customer concentration, where a few customers make up much of revenue.
• Revenue recognized inconsistently, such as booking annual contracts all at once.
• Missing or late sales tax filings, which can create exposure the buyer would inherit.
• Unrecorded liabilities like unpaid bonuses, gift cards or warranty claims.
• Working capital that looks different from what you describe.
• Add-backs that keep growing.

For tax questions, see tax due diligence in M&A, and expect that a buyer's advisor may perform a review of your earnings; what sellers should expect from a quality of earnings report explains the process.

Buyers usually expect the business to be delivered with a normal level of working capital, and the purchase agreement often includes a target. They'll compute a monthly average of receivables plus inventory minus payables over the past year and compare it with the level at closing.

Get ahead of it by calculating your own average, noting seasonal swings and explaining any unusual months. If you collected a large receivable early or stretched payables to boost cash, a buyer will see it in the monthly data. Build the schedule the way a buyer will: receivables plus inventory minus payables, measured monthly, so your numbers match how buyers measure.

A workable plan for a small business:

1. Days 1 to 30: close the books monthly, reconcile every bank and credit card account and clean up the chart of accounts.
2. Days 31 to 60: produce accrual statements, build the add-back schedule and gather tax returns and contracts.
3. Days 61 to 90: prepare customer and revenue schedules, working capital analysis and a debt and lease summary, then organize everything in a data room folder.

Ask your CPA to review before anything goes to a buyer, and consider a sell-side review if the deal is large. Marketplaces such as Acquire.com and Flippa can help you find buyers, but they don't replace your own preparation; ask each how it verifies seller financials and what buyers expect to see.