Transparency in Earnings

Transparency in Earnings

By Jim Zipursky

October 19, 2009

Not Just For Big Companies

Recently, I was asked to speak to a group of CEOs of mid-sized companies regarding EBITDA and its importance to them as business owners. Several questions from the group centered on what I will loosely call “tax avoidance” and “tax deferral” practices commonly employed by owners of privately held companies. The questions focused upon the impact of these practices on the value of a business. The common theme from the audience was, “buyers understand owners do not want to pay taxes and they are willing to adjust for these practices.”

I reminded the group that buyers, or anyone who is reviewing the performance of their companies, will only be able to evaluate what they can see. If you are writing off inventory, expensing personal items, or employing any of the myriad other “tax avoidance” practices, you do a nice job of lowering your tax burden, but you may not be able to get a return on this “investment” when you look to “withdraw” these funds. All of these practices impact your cash flow positively for you, but not necessarily for those evaluating your company.

One of the CEOs said to the group, “I never thought about this until I needed to borrow money this year to support our business. We have plenty of assets, and I thought a loan would be easy. Every bank we spoke to turned us down because our cash flow was so low. I tried to explain about our inventory being undervalued and the family vacations I paid for out of the business, but the bankers were not interested. You can be sure in the future, I will show the profits, pay the taxes, and make my life easier.”

If you never plan to sell your business, never plan to borrow money and never plan on being audited by the IRS, you have no worries. However, if you might ever consider selling your business (even to an insider), might find yourself in a position to borrow money, or have the unfortunate opportunity to meet with your local IRS agent for an audit, the more transparent your earnings, the better off you will be. Of course, you can pay yourself a huge salary and/or bonus, everyone can see the impact of this on the business. This adds to transparency. We call this investing in taxes. Otherwise, with limited transparency, your options are limited as well.

posted by Jim Zupursky