Structuring deals with a large gap between accrual and cash accounting

June 14, 2024

by a searcher in Toronto, ON, Canada

If anyone has structured deals where cash flows significantly lag accrual accounting, would appreciate the perspective on how you valued and structured the deal, negotiated with lenders, etc. Thank you!

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Reply by an intermediary
in Campbell, CA, USA

I had a business for sale that was doing about $12MM in revenue and the business was using cash accounting. There was about $4MM in inventory that was not on the balance sheet because it was expensed in COGS as it was purchased. This drove earnings down to about $500k. When we converted the numbers to accrual accounting, the earnings were about $1.5MM. The SBA lenders we talked with wouldn't consider the business for a loan, even though they admitted the business was really making $1.5MM, because the tax returns were filed with the cash accounting numbers. As to valuation, we valued it based on both accounting methods and came close to the same asking price. The cash basis valuation was a multiple of earnings plus a percentage of the inventory and the accrual basis valuation was based on a multiple of earnings including inventory. If any lenders out there can help me with this, please DM me.

Reply by a searcher
from Massachusetts Institute of Technology in Boston, MA, USA

There can be several nuances depending on multiple factors such as for instance the specific industry, business type like distribution, manufacturing or service, inventory amounts if any, receivables and aging, any regularly known uncollectable debts etc. - but overall conceptually one would perform the “valuation” off of the accrual financials, and address the offset in cash/accrual via the working capital peg. On the same token, one would want to look at the cash financials carefully to make sure they reconcile properly as well as understand the cash flow issues at hand and how the staggered or delayed cash flows impact business operations.

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