Clean Bookkeeping is an essential aspect of running a business. It involves maintaining accurate financial records of all transactions, including income, expenses, assets, liabilities, and equity. But it also means keeping the finances of the business and the owners separate – or at ‘an arm’s length’. Whether it is needed either for restructures, a transaction, or even for a dispute, the extent to which the business is kept at an arm’s-length to its owners will have a direct and substantial effect on the business valuation.

When two parties conduct business at an arm's length, they are expected to act independently and make decisions that are in their own best interest, rather than being influenced by personal relationships or conflicts of interest. In the case of an owner and their business this can be tricky, but keeping separate finances is a step in the right direction to ensuring that the interests of the business and the interests of the owner are not confused.

That means the finances should be free of non-business expenses so that when you look at the financial reports for the business, you are seeing the performance of the business alone, rather than a murky mixture of personal and business expenses all rolled into one. If a business was to pay for a spouse’s car, personal travel, renovations to the family home, and the like, a reduction in the saleable value of the business is inevitable. I have often observed businesses, where the owners have dipped into the till, and find themselves strapped for cash in leaner times, as they have pulled out available cash in times of plenty. The result is that the business struggles.

Of the thousands of businesses we have valued over the years, we would estimate that less than 5% (or 1 in 20) of them have no personal expenditure running through them. This means we can easily look at the trading history and current financial position of the business without relying upon a bunch of adjustments that the client is telling us aren’t business related. These businesses are easy to value and desirable to a purchaser because the level of guesswork and reliance on someone’s approximation is vastly reduced, meaning that it is a less risky purchase.

Some businesses (this time around 10%) treat their businesses like a piggybank; simply pulling money out left and right, paying for personal expenses with impunity, and accounting for it poorly. As an example, we had a recent client provide me with pages and pages of approximated ‘personal expenses’ that they wanted us to add back to the profit to provide its ‘real’ profitability. Nearly all of these adjustments were based upon their opinion, and if a buyer scrutinised them the seller would be hard-pressed to provide evidence to support their position. This would likely result in the purchaser not going through with the transaction or to vastly reduce their offer due to the perceived riskiness of the performance of the business.

And would you blame them? We certainly wouldn’t.

Here’s a test that you should apply to pretty much all the tips we give you:
When faced with two businesses that you could buy that are pretty much the same – they have similar turnover, profit, and locations: one is doing X and the other is doing Y, which one would you pay more for.

In the end, the mixture of personal and business expenses running through a business is a bit like muddying the water. As good as any business valuer is, they can only filter the water so much. It will never be completely clear and will be tainted to any prospective purchaser simply because of how muddy it was. They just don’t trust that it’s all clear now…

Sometimes business valuations aren’t just about the easily quantified risks. It can simply be the perception of the risk in a potential purchaser that reduces their appetite to purchase, and thus they are less willing to spend money on the purchase, thus seeking a discount before the perceived risk becomes palatable to them.

The takeaway from this: Don’t muddy the waters in the first place.