The red flags buyers find in your numbers

A buyer who likes your business will still go through your numbers line by line before they pay for it. Due diligence is where a promising deal can lose value, slow down or fall over, and it usually happens because of things the seller could have found and fixed beforehand. Knowing what a buyer's accountant looks for lets you deal with it on your terms rather than theirs.

Why small issues become big ones

A buyer is pricing risk. Each unexplained figure raises a question: is this a one-off, or a sign of something else? If the answer is unclear, the buyer protects themselves by reducing the price, asking for more warranties, holding back part of the payment or walking away. A single problem might be minor. Several together tell the buyer the records cannot be relied on, and that affects how they read everything else.

Red flags in the financial statements

Accounts that do not reconcile

Buyers compare the profit and loss and balance sheet with bank statements, BAS lodgements, payroll reports and tax returns. If revenue in the accounts does not agree with GST reported to the ATO, or wages in the ledger differ from payroll and superannuation records, the buyer will ask why. Differences may have innocent explanations, but each one needs a clear answer.

Unsupported add-backs

Normalised earnings depend on adjustments for owner salary, personal expenses and one-off items. An add-back with no invoice, no clear business explanation or no consistency between years will usually be rejected. As an illustration, if a seller claims $80,000 of add-backs and only $30,000 can be shown, the buyer will base value on the lower figure. See how much your business is worth for how add-backs feed into value.

Cash that is not in the books

Some sellers tell buyers that the business earns more than the accounts show because some cash takings were not recorded. Buyers will not pay for income that does not appear in the records, and the statement itself raises serious concerns about tax compliance. It is a red flag to avoid creating, not one to explain.

Inconsistent accounting

Changes from year to year in how stock is counted, when revenue is recognised or how costs are classified make trends hard to read. A sudden jump in gross margin, for example, may simply reflect a change in stock valuation. Buyers will look for these changes and may undo them.

Declining margins or revenue quality

Revenue growth driven by discounting, a single large job or one-off contracts is weaker than steady, recurring income. Buyers look at gross margin trends, the mix between recurring and one-off revenue, and whether recent results are being flattered by unusual items.

Red flags in the balance sheet

• Aged debtors that have not been collected or written off, suggesting revenue that may never turn into cash.
• Stock that does not match the count, or obsolete stock still carried at cost.
• Related-party loans between the business, the owner and associated entities, often with no clear terms.
• Overdue tax debts, payment plans with the ATO, or outstanding BAS lodgements.
• Unrecorded liabilities, such as employee leave not provided for, customer deposits or warranty obligations.

Red flags in payroll and compliance

Payroll is a frequent source of findings. Buyers check that:

• staff are paid at least the correct award or agreement rates, including penalties and allowances;
• superannuation has been paid in full and on time;
• workers treated as contractors are not, in substance, employees;
• leave balances are recorded accurately.

Underpayment issues can create significant liabilities and reputational risk, particularly in a share sale where the company carries its history with it. See employee entitlements when a business changes hands.

Red flags in the business itself

The numbers often reveal commercial risks too:

• Customer concentration. If one customer provides a large share of revenue, losing them after settlement could badly damage the business.
• Owner dependency. If sales, key relationships or technical work all run through the owner, the profit may not survive the handover.
• An expiring or unassignable lease. Without secure premises, the buyer may not get finance or may not be able to keep trading.
• Supplier dependency. Reliance on a single supplier or on terms personal to the owner.
• Personal and business spending mixed together. It makes true profit harder to establish and suggests weak controls.

Most red flags are not fatal on their own. What damages a deal is finding them late, with no explanation ready, after the buyer has started to lose confidence.

How to get ahead of them

1. Do your own due diligence first. Review your records as a buyer would, ideally a year or more before going to market.
2. Reconcile everything. Make sure the accounts, BAS, payroll, superannuation and tax returns agree, and document any differences.
3. Build an add-back schedule with evidence for every item.
4. Clean up the balance sheet. Collect or write off old debtors, deal with obsolete stock, document or repay related-party loans and bring tax lodgements up to date.
5. Fix compliance issues such as underpaid superannuation or award rates, with advice, before a buyer finds them.
6. Disclose what remains. An issue explained upfront is treated very differently from one discovered.

Our guide to preparing your business for sale sets out a broader timeline for this work.

How we can help

Kainos reviews sellers' financial records the way a buyer's accountant would, identifies issues early and helps fix or explain them before a sale. For buyers, we carry out financial due diligence and explain what we find. In both cases we advise and represent clients through the process, alongside their lawyer. To talk about your business, contact us or read about our accounting service.

This article is general information only and does not take into account your circumstances. Speak to a qualified adviser before acting on it.