What happens when your ecommerce business is doing well and scaling, and someone starts asking questions about buying the business? It sounds amazing, but are you even ready for the conversation? Today, Christian Rivera from The eCommerce Accountants comes on to talk about how you can get your business ready for an exit.
Izach Porter: You’re listening to the Deal Closers Podcast, brought to you by websiteclosers.com. A show about how to build your e-commerce business to be profitable, scalable, and one day even sellable. I’m Izach Porter and on the show today, we’re joined by Christian Rivera, founder of Ecommerce Accountants, to talk about how to get your financials in order to help you exit.
So I want you to think about your business. Let’s say you’re doing pretty well. You’re growing, and you’re in a company notices what’s going on and they start asking questions about buying your business. This sounds fun, but are you even ready for this conversation? And more importantly, are you ready for the due diligence process where the buying company will poke and prod all of your financials? If you’re like many of our clients, when we start working with them, those financial statements may be kind of a mess. And that acquisition conversation needs to be postponed a bit until we can help you get your financials to look as attractive as your business itself actually is.
So let’s talk about what we need to do to make that happen. Let’s welcome. Chris Rivera to the conversation, Chris, how’s it going today, man?
Christian Rivera: Doing well it’s a crazy time in the year, so it’s the beginning of tax season. So we’re a bit underwater, but anything for you, Izach? We’ve done a lot of work together,
Izach: Yeah. Appreciate it. We.
Christian: have to support you here.
Izach: Yeah, I love, appreciate you being on. I know it’s busy time and we’ve got a lot of mutual clients that we have worked with and are working with and, you know, everyone just raves about your firms. So I really thought you’ve got some great advice on how to prepare financial statements to get ready for an exit.
So, let’s start off on the buyer side. What financial statements are potential buyers looking for when they’re looking to buy an e-commerce or tech company?
Christian: Yeah. So one of the biggest things we tell clients, you know, as an established business owner, you have to make sure that your financials are in order because, you know, selling your business is just one of the very many reasons why you need clean, accurate, ready to go financials. You know, if you want to borrow money to buy a house, you want to borrow money for the business.
You want to sell your business. You want to do your taxes everything there’s a lot of reasons for why you need to be neat and organized and ready to go. If you have someone who’s interested in buying your business, right. If they ask you for financial statements and you’re like, yeah sure, let me just give me three to four weeks to clean up my financials and then I’ll get back to you, they’re gone, you know, they’re going to lose interest. You want to be ready to rock immediately. So in terms of what potential buyers look for, they want clean, accurate financial statements as soon as possible, because people’s interest levels change all the time.
So usually what I see in terms of accounting statements, Income statement and balance sheet, both of which are reconciled to, you know, bank accounts, credit cards, payment processors, et cetera. So clean, accurate financial statements, reconciled to very reliable primary sources.
Izach: A hundred percent, yeah. Okay, so let me, let’s dig into that a little more. If the reconciled piece, this is a key differentiator, and I think what you do with your clients. So what, the situation comes up for us quite a bit where, you know, a lot of our clients are using QuickBooks, which we love or other accounting software, and that software will output, an Excel spreadsheet with the P and L.
And so as we’re getting ready to prepare the financial statements in the event that are personal expenses on the P AND L, or other non-recurring expenses, you know, what a lot of clients will suggest is, hey, let’s either just delete those off the P AND L or move them to another section of the P and L right. And so what, what’s the challenge with just modifying your P and L if you’re not reconciling, what is reconciling mean?
Christian: Right. So here’s the situation, you’re kind of dealing with two different areas here. When it comes to selling your business, right? You’re selling your business for usually for a multiple of what, you know, your profits are, or your EBITDA or whatever,
Christian: So you want that profit or EBITDA number to be high because if you add a multiplier to that, you know, you want it to be high.
Now it’s an inverse relationship with taxes. If show, if you show high income for taxes, you’re going to pay a lot of money in taxes. Right? So it’s kind of like an inverse relationship. So realistically, here’s a situation: when we work with clients for tax planning or doing accounting for taxes or doing tax returns, et cetera, we’re deducting a lot of things that are more personal in nature. You know, the business car you have, some of your travel expenses, meals, you know, those are things that we’re very likely deducting to get to your taxable income or your profit number to tax right.
Izach: Yeah. And that’s completely, that’s completely reasonable. It’s totally legal. And it’s really, it’s actually just good tax planning to take advantage of the tax code that we’ve got.
Christian: Absolutely. Right now here here’s the other side to it. If someone’s coming into acquire your business, they’re not acquiring the business that included your meal with a business partner that you deducted for tax purposes. Right? So we view that as more personal in nature. So what we typically do with clients that, you know, we’ve worked together on is we take your P and L that we use for taxes, et cetera, and that is anchored into a tax return.
So if a perspective buyer comes in and they want to rely on the numbers, they can take a look at the QuickBooks account. They can take a look at the tax return accountant, understand or the tax return itself, and understand whether or not those numbers are reliable. Now, also what’s important is we need them to understand that that’s not the business that they’re buying.
The business that’s presented on the tax return is presented strategically on the tax return for that for specific purposes, usually, you know, tax planning, et cetera. The business they’re actually buying, you know, It, we view it as if the way that we view the business that they’re selling is they need to strip out certain things that aren’t really applicable to the business-like meals.
You know, you’re not buying a business that has X amount of meals, maybe the new owner’s going to come in and spend less on meals or travel or other expenses that are more personal in nature. So what we typically do is our starting point is financials that anchor into a tax return and QuickBooks, and we make adjustments to remove those personal items out.
Izach: Yep. And then are you making sure that those adjustments that are made on the P and L reconcile back to QuickBooks or so that when we go through, you know, cause the, I think the, the question is when we go through due diligence, how does a buyer get comfortable that those expenses that we’ve either removed or, or segregated our personal expenses and how do they, how do they actually see that paper trail?
Christian: Right. And you hit it right on the head. That’s why we show two different versions. We show one version that says, hey, listen, if you want to see our numbers presented on a tax return, you want to see our numbers on QuickBooks. You know that those are our tax planning numbers. So we present that one way and you can very easily reconcile it to bank accounts, credit cards, tax returns, et cetera.
But we present separately on the financials, your real personal expenses, things like we’re talking about the car, the meals, the travel, that kind of stuff. We break it out separately so that if the perspective buyer wants to dig in. And make sure that the numbers in your listed P and L reconcile to your tax return, to QuickBooks, they can easily work their way back into understanding where the numbers came from.
Izach: Yeah, that’s So key.
Christian: Bridging it is so important.
Izach: Yeah. So key. And what I explained to, to both buyers and sellers is the cashflow that we’re representing in our marketing materials is the cashflow that’s going to be available to the buyer and that doesn’t include these personal or discretionary expenses of the owner. And that’s why we’re breaking them out, you know, removing them or putting them below in some cases below operating income. So, I think, you know, what, what you’re able to do in reconciling that back to the, to the original accounts and then showing kind of how to get from tax return to the P and L as it’s presented, with an orderly methodology is really key.
So a couple more questions that came to mind. We see a lot of financial statements that are presented on a cash basis, and we often will convert to accrual. So from your perspective, as a, as a CPA, can you just explain the difference between cash and accrual and why that could be important in a sale process of the business?
Christian: Absolutely. So cash basis accounting is very common for small businesses, and the whole idea is expenses are, items or expense or recognize and income as they actually affect your bank account or credit card, et cetera. So an example is when you swipe that credit card for Facebook ad spend, that’s when it would be counted as a deductible expense, whereas accrual basis is really as you accrue, which basically means when you owe the money.
So same example, if you run up $500 in Facebook ad spend and they didn’t charge your credit card yet, in theory, on accrual basis accounting, you’re technically supposed to consider $500 as expense, right? Same thing works on the revenue side. Right? So it’s a little bit more uncommon with e-commerce, but let’s say you, you have an invoice-based business where you send an invoice to a customer and you have to wait for them to pay it right.
In theory, on a cash basis, accounting methodology, you recognize income when that customer actually pays you, whereas an accrual basis accounting, as soon as you send that invoice and you’re waiting for them to pay, you have to recognize it as income, right? Whether they pay or don’t. So the way that we like to structure e-commerce businesses, accounting wise for when they list, is what I like to call a modified accrual basis accounting.
So we avoid doing hardcore accrual basis, accounting for things like ad spend for things like payroll, for things that, things that don’t really move the needle that much and focus more on presenting the financials in a modified accrual basis for things like inventory and sales.
Izach: Inventory is the big one, right? Inventory and revenue, because the, on a cash basis the owner of the business is going to recognize their inventory purchase and these big lumps, they put in a hundred-thousand-dollar order gets shipped from China, right. And so when they, when they pay for that on a cash basis, that entire cost of the inventory shows up in one month.
It creates a lot of volatility. So let’s talk about, I think this, this modified accrual concept is interesting. So let’s just say, just keeping it specific to inventory. You know, the scenario I described where all the inventories expensed that one month, how would that change on accrual.
Christian: Yeah. So I just want to take a step back from that for a second. Oh, it’s a common misconception in this space that inventory is fully deductible on a cash basis. Per the IRS rules you’re technically required to do, even if you’re a cash basis taxpayer, you’re technically required to do inventory accounting on an accrual basis.
Right? So the whole idea is if you’re a drop shipper, right then it’s very, very easy to deduct, you know, your cost of goods as you actually pay it. But if you are in the business of actually keeping an inventory in the US or in China or wherever, and you actually buy in bulk, units that are sitting somewhere and you’re selling them, you are technically required to do inventory accounting on an accrual basis.
And it’s extremely important. A lot of online entrepreneurs, they think, oh, well, you know, it’s December 15th, let me just buy up a bunch of inventories. And I could deduct it on my taxes and show zero profits and not pay any income taxes. And it actually is not supposed to work that way. And it’s a high-risk area under audit.
You know, if you’re an online seller and you’re under audit, that’s one of the first things that the IRS is going to look for. They’re going to say you’re an e-commerce seller. Great. If you have inventory, why are you deducting it? You can’t deduct inventory until you sell it. That’s the whole idea behind accrual basis accounting.
So when you buy inventory, which you’re technically supposed to do is you capitalize it on your balance sheet. So for example, if I buy $75,000 worth of inventory, technically none of that’s deductible, it’s supposed to sit on your balance sheet, and you deduct deducted as you actually sell the units.
And the intent is for obvious reasons, the IRS doesn’t want you to fudge your numbers and buy up a bunch of inventory strategically around tax deadlines so you don’t pay any taxes. So the whole idea is to prevent that sort of tax planning strategy. You’re technically required to do accrual basis inventory accounting, even if you’re a cash basis taxpayer.
Izach: I know you’re seeing that done the wrong way.
Christian: Oh, absolutely.
Izach: Yeah, cause I see it that way pretty frequently. I see inventory on a cash basis frequently.
Christian: well, don’t get me started on how, how often I see other accounting firms screw up e-commerce sellers like financial statements, because it is complex.
Izach: Well, this, this is a great point. And this is why, you know, I, I recommend our clients to talk with you because you, you specialize in e-commerce right. And there’s some nuances to your company is the Ecommerce Accountants. So there’s nuances to the accounting requirements for companies that are with these business models that, that you focus on and can really, I guess, help people protect from audits. I didn’t even thought about it that way, but that’s, that’s a key.
Christian: Yeah, because when you file your tax return, you file it with a code that says what type of business you have. So the IRS automatically gets a code that says, oh, I’m an e-comm seller. So if they get that code and then they take a look at your tax return and you don’t have inventory capitalized on the balance sheet capitalize, meaning, not deducted sitting on your balance sheet.
You’re a target for audit. So it’s very, very important to get that right, but to touch on your point accrual basis accounting for inventory is also extremely important for selling your business. Because if you don’t, if you just do cash basis accounting for your inventory, it could be extremely misleading.
I’ll give you a simple example. Let’s say you had a hundred thousand dollars in sales in January, a hundred thousand dollars in sales in February. Right? If you buy up a bunch of inventory in January, let’s say $150,000 worth of inventory. On a cash basis, you know, you’re deducting all that. You show a loss in January.
Then in February, you have zero expense for inventory because you didn’t buy up any new inventory. So what winds up happening is it creates like a staggered P and L, where it’s like you have $200,000 a month in terms of sales, they were probably equally as efficient in terms of, in terms of return on your ad spend or whatever efforts you have to generate sales.
But the financials are misleading because in January spent a ton of money in inventory in February didn’t. So it creates like a staggered P and L, which to prospective buyers causes concern because you’re like, wait a minute, you get back-to-back a hundred thousand dollars months. Why did you lose so much money in January?
But you made a ton of money and February. It’s just extremely misleading.
Izach: It’s very confusing for buyers to see it that way. And it looks, it makes the margin look like they’re all over the place.
Christian: And the easiest way to turn off a perspective buyer is confuse them and make them, if there’s any uncertainty at all, they’re going to opt for in a different direction for a company that does have accurate and more reliable and financial data that makes sense.
Izach: Yeah. Yeah, for sure. And I think, you know, the situation that we see come up quite a bit is we’re working with companies with high growth rates. So through the course of the last 12 months that we’re looking at whatever that period is they’ve built up inventory, right? So they’re, they’re trying to build their, their inventory to keep up with the demand as it grows.
And so they’re purchasing more inventory than their, than their sales reflects. So if they’re expensing all that inventory, it makes their profit look dramatically lower. And so when, you know, when we work with you to convert to accrual, we kind of unlock this cashflow, which really can improve the value of the business.
So let’s talk about some red flags. You mentioned some audit red flags, but what would be some red flags for a buyer of an e-commerce business? When they’re, when they’re looking at financial statements?
Christian: So the best way I like to describe it is anyone can put numbers on a page and say, see, here’s my business. My business generated $10 million in sales, and we did 1.5 million in profits, right? So in the due diligence process, due diligence is basically a formal way of saying BS, those numbers are made up. We want to review everything right.
So the whole idea is you can have financial data, but the reality is it’s a piece of paper. It’s only as good as the supporting documentation, right? So in terms of red flags for buyer, if you’re going to present numbers and send them to the perspective buyer, you need to make sure that you have backup to help that buyer understand where those numbers come from.
So step one, in my opinion is you want to have complete and thorough bookkeeping processes, reconcile the bank accounts and credit cards. That means all of your bank account and credit card transactions for your business entity should be reconciled in a QuickBooks account, right? So, or whatever accounting software you use. For small businesses, we usually see QuickBooks and that’s what we use for all of our clients.
So once you get beyond that, you also have some other things you have to do. You have to make sure your inventory accounting is accurate. If you’re going to deduct X amount of inventory, how much of it was not yet deductible and sitting on your balance sheet and where did that number come from? So one of the most complicated parts of e-commerce accounting is accounting for inventory.
You know, if you’re saying you have $75,000 of inventory that you haven’t sold yet, the question is, how did you come up with that number? You paid 150,000. You sold a bunch of units. Where’d you get 75,000? You have to have clean and thorough documentation that supports the number that you’re presenting to prospective buyers. Right? Because that’s one of the numbers they’re going to look at. It’s probably the biggest number on your balance sheet or one of the biggest numbers on your balance sheet. Right? So that’s another point.
Accounting for sales is extremely important. This is a big audit red flag, but also a big perspective buyer red flag. The issue, and this is another complex thing with e-commerce accounting, is revenue recognition is extremely confusing. If you generate, let’s say $10,000 in sales on Shopify, right? You’re not going to get $10,000 into your bank. You’re going to get $10,000 minus the merchant fees, minus chargebacks, minus, you know refunds, et cetera.
So the whole idea is you have a mismatch, you have $10,000 in sales per Shopify, but you have $9,275 that actually hit your bank account. So the question is what’s the difference? So a lot of bookkeepers that aren’t experienced with e-commerce, they’ll say you have $9,200 of our, whatever, $9,200 of revenue.
When in reality, you had $10,000 in revenue. So when that prospective buyer comes in and looks at your Shopify dashboard and says, wait a minute, you have $10,000 in sales here, but when I look at your P and L that’s showing 9,200, what’s the difference, right? Those are the kinds of things that would turn off a perspective buyer.
So you want to make sure that you’re anchored into the right places. Things that are bundled together like merchant fees, refunds, charge, backs, et cetera, that stuff’s all broken out. So it’s accurate when you, whenever someone’s reviewing the financial statements.
Izach: Yeah, I mean, it’s, it’s so important to have clean financial statements that are reconciled when we, when we get into due diligence, you know what happens is if buyers come up with this big list of questions and things don’t make sense, they’ll back out of a deal just because they feel like the owner doesn’t really have a handle on the financials or they get, or they get scared. Like, hey, if this isn’t right, what else isn’t right. And of course we, we work with, you know, we work with sellers’ hand-in-hand to make sure that they don’t get into that situation to begin with, because we want to make sure that when we get to due diligence, that it goes smoothly.
There’s always going to be questions that come up in any due diligence process, but we want to make sure that all of these, the things that we know are going to be looked at are going to, are going to reconcile, and we’re going to have supporting data and documentation for the buyers. And we want to, we want to put that in a shared drive and make it, you know, kind of tee it up and put a bow on it. And because we know everybody pretty much goes through the same process and we want to make it as easy as possible for the buyers, which ultimately gets our sellers the best, the best value for those transactions.
So, is it worth getting professional help with your financials? If you’re thinking about getting into a sale process?
Christian: Absolutely. And I would actually say it’s important to get a professional help before that process. just because here’s the deal, accounting and taxes is very complex and you know, I’m a tax guy. That’s my original background. So to me, you know, calculating a tax number is actually quite easy, easier than most people think.
If you give me a profit number, I can calculate a tax in probably less than five minutes. And get very, very accurate. But the issue is having a good profit number, right? That takes a lot of work. That’s not easy. So I would say about 70% of the people that come in through the funnel and want to work with us, say, don’t worry about bookkeeping.
We got it. I’m like, no, I promise you, you don’t, especially if you’re doing it yourself because e-commerce accounting is complex for accounting firms, let alone you as an entrepreneur, you know, maybe you’re having a mom do your bookkeeping or you’re doing bookkeeping or your friend, or, you know, it’s highly complex.
And the thing is with e-commerce is a lot of these businesses can be scaled very easily, you know, it’s so, and we see companies grow very quickly. Having someone in your corner, maybe not from the start, but when you actually start generating serious revenue and the way we define that as $50,000 or more per month in sales, right?
That’s when you absolutely need someone in your corner that has an accounting background and understands e-commerce businesses specifically, mainly because of the inventory accounting, revenue recognition, you know, understanding whether your revenue is correct, et cetera. But if you get that process set up in place for taxes, it’s really, really easy transition to have all of the financial data ready for when you are ready to sell. Because realistically what’s going to happen is if you decide that, hey, I want to sell my business today, you’re not going to have a buyer tomorrow. What’s going to happen is people are going to come in flirt a little bit, see if they like your business and they may or may not purchase.
And that due diligence process can take weeks. It can take days. It can take months. You know, so it’s not like you can make the decision today and get your number set up for a perspective buyer tomorrow. You know, like it it’s highly complex. So my recommendation is always, if you’re generating significant revenues, again, that’s $50,000 or more per month in sales, you should have these processes set up in place, not even for selling your business, but for tax planning purposes from the get-go then when it comes time to sell your business, you already have this stuff in place, for you to pull the trigger quickly.
Izach: Yeah. And I can tell you from personal experience buyer or sellers that have clean financial statements and professional preparation get more money for their businesses. I think that that, that service will pay for itself at the time of exit, because as you go through that process and you know, a new month closes, you’ve got the financials ready, you’ve got, you’ve got a balance sheet and a P and L that are going to reconcile.
You’ve got, you know, the, all the initial high-level questions that a buyer’s going to ask and preliminary due diligence, they’re going to be easy to get the answers for. And so it makes a, it makes a buyer more confident and when they make an offer and because of that, they they’re willing to spend more money cause they, they know what they’re getting.
So what are, you know, what have you, have you seen any, any, any situations, you know, not naming any names of course, but just a of, of somebody that had, you know, something that was really messed up, you know, what are some horror stories, examples that you have, or examples of, you know, some, some financial statements that were really screwed up, you know, that impacted, you know, the, position of the business
Christian: So one of the biggest things I see, and we actually don’t take on clients unless they’re, they have this resolve. But, you know, e-commerce for a lot of e-commerce entrepreneurs is a side hustle till it’s not, you know, a lot of times people have a day job, they do e-commerce on the side. Then before they know it, they’re side hustles making more money than their main job.
Izach: For sure. Yeah, we see that a lot.
Christian: So what happens in the beginning when it’s a side hustle is maybe you use that personal bank account, personal credit card, and it’s co-mingled with the same account that, you know, paying your rent with, or going on, you know, Cancun to booze it up with your friends for the weekend, you know?
So it’s, co-mingled with all your personal. So super, super important. Have your business bank account business credit card separate from your personal bank account, personal credit card. Because again, during due diligence, if someone comes in and looks at your bookkeeping reports and they say, well, wait a minute, like this credit card has all kinds of transactions.
How do I know what your profits not low? Like how do I know what transactions you consider business versus personal? So you have to have that clear cut. You need to bifurcate clear business you as an entrepreneur and you as an individual. So you need to bifurcate that. So that’s very important.
And then obviously a back of the envelope profit calculation, without support reconcile to bank accounts, credit cards, same exact issue. You know, if someone comes in and wants to do due diligence and numbers that you made up, they’re not going to be able to figure out how you calculated those numbers. You know, it takes a significant, significant amount of work and ultimately lead them to going in another direction if the transaction value is too high and they perceive it as two risky
Izach: yeah, absolutely. That’s those are, those are both great points that you know, that we we’ve seen in practice as well. So, hey, what are some resources that you would recommend, you know, books, podcasts, YouTube channels, for our listeners to kind of help them get prepped, you know, either to, to, to start talking with you or to get you start the process of getting their financials in order.
Christian: So basically you can find us on all social channels. We’re on YouTube. Just look up the Ecommerce Accountants on social media. We have an Instagram account. We have Twitter. We have, tick-tock just find us at ecommaccountants. Very, very easy to look up for some reason, no one goes to the business page. You always go to my personal, which is Ecomm Accountant. And I really geek out I’m posting tax stuff on there all the time, but personal account that people usually follow them.
Um, But the best way to get in touch with us, if you’re interested in a consultation is visit our website at theecommerceaccountants.com. And there you can find a lot more content and links to our social channels and all kinds of stuff for you to kind of float around in our universe and geek out on accounting and taxes.
Izach: Chris really appreciate being, being on the show to talk with us today. That was Christian Rivera, who you can find at the e-commerce accountants.com or on his YouTube channel, just search for e-commerce accountants, and you’ll find him given more financial advice for your business.
Thanks everyone for listening to this episode of the deal closers podcast brought to you by websiteclosers.com. If you like this show, be sure to rate us, write a review, press the follow button and share it with your network. And of course, if you’re looking for help selling your e-commerce business. Be sure to visit websiteclosers.com.
This episode is edited and produced by Earfluence. I’m Izach Porter connect with me on LinkedIn and we’ll see you next time on the Deal Closers Podcast.