What a lender does with your management accounts

They are read more carefully than the filed accounts

Filed accounts are old. By the time a set has been prepared, approved and filed, the period it covers can be well over a year behind, and in an acquisition the lender is being asked to fund the business as it is now.

So the management accounts carry weight out of proportion to how carefully most owner-managed businesses prepare them. They are the only evidence of the current run rate, they are the bridge between the last set of statutory accounts and today, and they are the first place an assessor looks for a difference between what the business says about itself and what its own records show.

First they are reconciled, not read

Before anything is analysed, the management figures are tied back to the last set of statutory accounts. If the opening position in the management accounts does not match the closing position in the filed ones, that gets raised, and the answer matters.

Sometimes there is a good reason: post-year-end adjustments from the accountant, a prior year correction, a change of accounting treatment. Those are explainable and nobody minds. Sometimes there is no reason, which means the management accounts are being kept on a different basis from the real ones and cannot be relied on for anything.

The same reconciliation happens sideways. The sales figure is checked against the sales ledger and often against the bank. A contract or fee schedule provided separately is checked against the revenue line. Where a business has given a lender three documents, the assessor will make sure all three tell the same story before believing any of them.

Then profit is rebuilt from scratch

The profit figure in the accounts is almost never the profit figure the lending decision uses. It gets rebuilt, and the rebuild has two halves.

Things get added back. The owner's drawings above a market salary, a vehicle nobody needs, family members on the payroll who do not work in the business, one-off legal costs, an exceptional bad debt. These are genuine and they usually improve the picture.

Then things get put back in, which is the half sellers forget. If the owner is leaving, the cost of whoever replaces them goes into the figure at a realistic market rate. If a property is owned personally and let to the business at a favourable rent, a market rent goes in. If capital expenditure has been deferred to flatter the year, an allowance for it appears.

What survives that process is the number the repayments are measured against. It is often materially different from the headline, in both directions, which is why a price agreed on a multiple of the headline figure can meet an unpleasant surprise later. See valuation basics for how the two numbers relate.

The balance sheet gets more attention than the profit line

Buyers focus on profit. Experienced assessors spend at least as long on the balance sheet, because that is where distress shows up first and where a business that is trading well can still be running out of room.

• Debtor days and the ageing profile. A lengthening ageing usually means either collection has stopped or a customer is in trouble.
• Creditor days. Stretching suppliers is the cheapest form of borrowing and the easiest to spot.
• VAT and PAYE. Arrears here, or a time to pay agreement with the tax authority, change the assessment more than almost anything else on the page.
• Director loan accounts. Which way the balance points, and whether it is going to be cleared at completion.
• Work in progress. Especially where it has grown faster than revenue, which can mean work is being done and not billed.
• Existing debt and asset finance. Everything already committed, including anything that has to be settled on a change of ownership.

The shape of the year matters as much as the total

Twelve months presented as one column tells a lender very little. Month by month tells them whether the business is growing or shrinking, where the seasonality sits and how deep the trough is.

That last point is the one that sets the size of the facility. A business that makes its money between April and September has to pay wages in January, and the working capital needed to get through the quiet part of the year is a separate question from the money needed to buy the business. Buyers routinely fund the purchase price properly and then run short in month three. See working capital.

What makes a set unusable

Some management accounts cannot be used at all, and it is worth knowing which faults have that effect:

• No balance sheet. A profit and loss on its own cannot be reconciled to anything and is treated as an assertion.
• Cash in, cash out, with no accruals or prepayments, so timing rather than trading drives every movement.
• Several months out of date at the point of application.
• Inconsistent treatment between periods, so the trend is an artefact of the bookkeeping.
• Figures that do not agree with the bank statements provided alongside them.

None of these is fatal to the deal. All of them cost time, and time is the thing that kills acquisitions, because sellers lose patience and exclusivity periods expire.

What good looks like

Monthly, with a balance sheet, prepared on the same basis as the statutory accounts, available within a few weeks of each month end, and consistent across the period shown. Add a short commentary, half a page, explaining anything unusual: the month a large job completed, the quarter a customer left, the exceptional cost that will not recur.

The commentary is the cheapest credibility available in the whole pack. An assessor who has an explanation in front of them does not have to invent a cautious one, and every unexplained movement in a set of accounts is resolved against the borrower by default. Our document checklist sets out the rest of what tends to be asked for, in the order it tends to be asked.

Where we come into it

Clean management accounts do not by themselves get a deal funded, but untidy ones reliably slow it down and often lose it. Getting them straight is the cheapest work a buyer or a seller can do, and it is worth doing before anyone outside the business sees a number.

After that, the question is who is reading them. A funder that has lent into accountancy practices or HVAC businesses before knows what a normal balance sheet looks like in those sectors and what an unusual one means. We know this market and we know specific people who have funded businesses like these before, so the same figures land in front of someone who recognises them. Tell us what you are buying and we come back to you with who can fund it and what they will want to see.