As we move past the pandemic we’re dealing with financials that have been through what anyone would consider unusual times. So how does a business owner or business buyer analyze a business that’s survived a pandemic? What should one look for when judging pandemic performance?
In his article we will explore this as well as some trends that we saw in the pandemic as well as what to look for regarding government funds businesses absorbed to support businesses through the pandemic.
Previously to the pandemic when I ask for financials from a business I would ask for three to five years of financial statements and tax returns. Since the pandemic I’ve asked for this but I’ve also asked for month-to-month profit-and-loss statements from January 2019 through the most updated month exported to excel in a single tab spreadsheet. The reason for this specific request is so that I can chart the revenues and net income on a month-to-month basis leading up to during and since the pandemic. It’s extremely important to see what happened when the business closed, and then more importantly how it rebounded after business reopened.
Some business has suffered very little especially if they had a drive-thru or were otherwise essential. But most businesses did suffer significant losses in revenue. This is to be expected during the pandemic. But comparing how business did in January in April of 2019 to April of 2020 to April of 2021 tells a different story.
Most people will expect a business not do well in March of 2020 but they will hope it will go back to its previous performance by April of 2021. This is a longer-term view, but by looking at the month of month view you should be able to discern how a business has performed through the pandemic.
A business that quickly rebounded to or exceeded pre-pandemic levels should be considered a strong business. As North Carolina and other states had a government mandated closing of non-essential businesses for many months, most businesses would be expected to have lower revenues and earnings in 2020, but those businesses that did not are the strong ones.
Looking Past the P&L:
So the answer to judging pandemic performance is to look at it on a monthly level on the profit and loss statement. But the story is not just on the profit-and-loss statement, the balance sheet also needs to be reviewed to look for loans that were received during the pandemic. Specifically the PPP loan as well as the EIDL loans are very important to isolate and discover if they were subsidizing revenues due to the pandemic.
If a business is to be sold the buyer and seller will want to know what loans are outstanding and what will happen to those loans after the sale. Without giving legal or accounting advice, a blanket statement is that most small businesses are sold as asset sales and they must be sold free and clear.
This means that any outstanding loans including PPP and EIDL loans must be satisfied at the closing. PPP Loans is especially interesting as they should be forgiven, but often times it they not forgiven before the closing. For this is the reason most PPP Loan funds are held in escrow when a small business is sold with an outstanding unforgiven PPP loan.
An important thing for a buyer to look for with these loans is to ensure they were not considered as operating Revenue. They can be classified on the financial statements either as “other income,” or just simply listed on the balance sheet as a loan received. As long as these proceeds were not represented as regular sales of product or service there are numerous methods in which the proceeds can be represented correctly.
Some business buyers have made claims that business owners have compensated themselves more than they would have because they received these payments and that they would not have paid themselves as much had they not received these funds. This can be a subject of debate, but looking at the long-term history of what the owner has paid him or herself can help resolve these claims.
Staying on the topic of payroll, it’s also worth recognizing the fact that during the pandemic many businesses, although their revenues may have been reduced, enjoyed stronger earnings. This was because some business changed to a new method of dealing with the pandemic such as drive-through only or pickup and delivery. Often less labor was needed in these cases and many businesses became more profitable during the pandemic because they spent less on payroll. Business buyers investigating the purchase of a business should closely scrutinize how the business made money and if profitability that was garnered during the pandemic is sustainable when the business enters the “new norm.”
These are some of the aspects to be considered when analyzing business for pandemic performance. If you are considering buying or selling a business and have questions about how the business handled the pandemic and if it’s sustainable, consult a qualified intermediary to assist you with this important analysis. Buying or selling a business is a complicated venture in normal times; adding a pandemic to this puzzle doesn’t make it any easier!