Becoming Succession Ready: Financial Analysis
When preparing for your practice succession, the state of your financials is an area of significant importance. Start by analysing your financial performance over the last three to four years. Are your revenues trending upwards, downwards, or stable and why?
Personal expenses may need to be ‘added back’ and normalised financials presented as you move towards your succession. Are your normalised profits increasing over the last three to four years? If not, why not? Is your business recording your work in progress each year? What are the leave provisions for staff? Is there excessive leave? Is remuneration for family members above market? You will want to present your financials positively. Start planning how you want to present your financials when you start your succession.
When your successor analyses the revenue trends of your business, they will interpret different trends in different ways based on their individual circumstances, goals, and risk tolerance. In general, your successor will consider the revenue trends in the context of the broader financial performance of the business, including your business's expenses, profitability, and cash flow. Your successor will consider factors such as the industry and market conditions, competition, and the quality of your business’s services. Ideally, you will want your business revenues trending upwards over the last three to four years leading into your succession. Stable revenues, year on year, are ok. What you don’t want is decreasing revenues each year, this will erode confidence in the sustainability and value of your business.
It is common for personal or private expenses to be included in financial statements. Ultimately, financials will be adjusted, and normalised financials will typically be presented to your potential successor(s). Common expenses that would be ‘normalised’ include the owner's salary and benefits (particularly if the owner’s salary is either above or below market rates), personal car and travel expenses, depreciation, interest, personal entertainment expenses, home office expenses, non-business-related insurance, and personal investments. Where there is an adjustment to the owner’s salary, it is important to reflect an actual market salary for each partner or principal.
As you approach your succession, if you have excessive WIP recorded, you may need to ‘clean up’ your WIP, so your WIP is reflective of only ‘fully recoverable WIP’. It is often advisable to reduce your WIP as much as possible. In fact, many clients are recommended to issue interim invoices (assuming they typically issue invoices at ‘end of job’) in the lead-up to Completion and present their business at ‘Completion’ with zero WIP. Managing WIP after ‘Completion’ can present a host of challenges. If there are write-offs post ‘Completion’, because the transition has resulted in a client job taking longer than expected, does this affect your current WIP? Issuing interim invoices and having zero WIP at ‘Completion’ removes many challenges post ‘Completion’.
Staff leave entitlements should be reviewed and sanitised if there are excess levels. Encourage selected staff members to take time off to reduce leave balances. Typically, your Purchase Price is adjusted at Completion for transferring leave entitlements. Your successor may not be enthusiastic about taking over a staff member about to go on leave for two months.
If family members work in your business and are paid ‘above market’ rates for their role, unless there are compelling reasons relating to their output, they may likely be subject to a ‘realignment’ of their salary to market rates. Of course, all things are negotiable, but an ‘above market’ employee salary is challenging for most employers.
In the lead-up to your succession, you must take the time to analyse your financials and start preparing how you want your financials to be presented to your successor. You will likely be handsomely rewarded for your efforts during your succession.