by Kim Harrison
Volume 9, Issue 16, August 2, 2022
During the healthcare M+A process, the benefit of accurate financials cannot be understated. Financial reporting is the foundation on which your business is valued, and meaningful data presented in an organized fashion can lower a buyer's perceived risk. This likely means more money in your pocket on the closing date.
Yet, it is an all-too-common occurrence to see frustrations arise as a healthcare business owner works through the financial due diligence process. The lists are exhaustive, the requests elaborate, and the stakes high. By taking a few steps, even 3-6 months before you go to market, the due diligence process can be simplified in an impactful way. Sailing through financial requests allows an owner's focus to be rededicated to other, equally important parts of the sale process.
Here are five steps to consider taking to better prepare your financials in anticipation of an exit.
The accounting method affects the timing of when revenue and expenses are recognized and can have a material effect on your profit and loss statement (P&L) from one period to the next. In accrual accounting, revenue is recognized when earned, and expenses are recognized when incurred, regardless of cash inflow or outflow. On the other hand, cash accounting recognizes revenue and expense as cash flows into or out of the business.
Let's look at a few examples that help show how cash and accrual method accounting differ.
Revenue example — A client entered a 30-day rehabilitation program on Dec. 1, 2021. The client uses insurance to pay for services, and the provider is reimbursed $10,000 for services on Jan. 15, 2022.
Accrual method: Revenue of $10,000 is recognized in December 2021 because that is when services were rendered.
Cash method: Revenue of $10,000 is recognized in January 2022 because that is when the payment was received.
Expense example — A provider receives an invoice for $15,000 from a medical billing vendor on Jan. 5, 2022, for services provided in December 2021. The provider pays the invoice on Feb. 1, 2022.
Accrual method: An expense of $15,000 is recognized in December 2021 because that is when the expense was incurred.
Cash method: An expense of $15,000 is recognized in February 2022 because that is when the invoice was paid.
While each method has pros and cons, the primary benefit of the accrual method is the matching of revenues with the expenses incurred to produce those revenues. This cause-and-effect relationship of revenues with expenses is called the "matching principle" and is a part of generally accepted accounting principles (GAAP).
The accrual method of accounting is usually preferred by investors as it paints a clearer picture of operating profitability. Although many business owners use the cash method of accounting due to its overall simplicity, this approach can result in unexpected and unfavorable adjustments to EBITDA and have an impact on working capital. Making the switch to the accrual method requires knowledge of advanced accounting concepts and may feel daunting. An experienced bookkeeper or certified public accountant (CPA) can make this transition with ease, and getting it done right is worth the additional expense.
Your P&L tells the story of your profitability and financial health by providing a summary of your revenues and expenses over a period. Just as it helps a business owner make informed decisions, buyers rely on this financial statement to make informed investment decisions. To be an effective decision-making tool, your P&L needs to be organized in a way that is easy to comprehend. A well-assembled P&L starts with the chart of accounts (COA).
The COA is a listing of all general ledger accounts and allocates each account into five primary groups: assets, liabilities, equity, revenue, and expenses. Accounts can be further grouped into classes, divisions, or departments, if desired. A little extra time spent when determining which accounts to use can save headaches down the road and add tremendous value to your financial reports.
Here are a few things to consider when organizing your COA:
Any changes made to clean up your COA should be deliberate and executed carefully. Consider how changes made will affect the comparability of financial data across years. The beginning of a fiscal year is the best time to make these changes. A seasoned accounting professional can be especially helpful in this process.
The P&L is only useful to the extent that it is analyzed. If you are only looking at the bottom-line number each period, you are missing valuable insight that could assist you in making quick decisions that drive value and profitability. Regular analysis of your financials is a habit that pays dividends and will position you ahead of the game when fielding questions from buyers.
These routine practices will allow you to speak confidently about your company's financial performance:
An accounting close process performed consistently results in meaningful and accurate financial statements on a timely basis. A routine and thorough close process for each month and year-end will provide a quick-to-access library of financial information you may be required to provide during the sale process. A well-designed close process yields the three must-have financial statements — balance sheet, P&L, and statement of cash flows — which allow users to thoroughly evaluate a company's financial soundness and a potential buyer to assess value.
A solid close process includes the following elements:
Creating a file that houses important financial documents in advance of going to market can be an easy way to save time and prevent unnecessary stress. The ability to easily locate important documents could prevent delays in the sale process and gives the impression of an organized, well-managed organization.
Documents to consider for this file include the following:
The goal of financial due diligence is to give a potential investor an understanding of ongoing profitability by examining historical performance, trends, forecasts, working capital needs, and other qualitative metrics. Allowing a third party to peek into the inner workings of your business can be burdensome, expensive, and overtaxing if you are not properly prepared. Completing the steps discussed above will start you on a path to an uncomplicated due diligence process while also helping you better manage your operations. It is a win-win.
If you are considering an exit and unsure how to get these processes in motion, please reach out to the healthcare M+A team at VERTESS.
In her role of Financial Analyst, Kim conducts reviews and analyses of financial statements to build a foundation for executive decision-making. She also provides valuation and operational-side consulting services. Her healthcare experience, prior to joining VERTESS, includes working as a CFO in the behavioral health industry, Controller for a toxicology laboratory, and Staff Accountant in a professional organization for dentists. She started her career as an auditor for Ernst & Young, working primarily with venture capital firms, and she has also held roles in the vending, hospitality, and advertising industries. Kim has been a key player in the M+A process from the seller and buyer side, and thus understands a company's operational needs and challenges in an M+A phase of their life cycle.
Kim earned an MPA (Masters in Professional Accounting) from The University of Texas, and a BS in Business from East Carolina University (4.0 GPA). She is also a licensed CPA in the State of Texas. Other achievements include being recognized as the College of Business Outstanding Senior at East Carolina University and as the Outstanding Senior for the Beta Gamma Sigma Honor Society. She is a registered yoga teacher with the Yoga Alliance.