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Tuesday, June 17, 2008

Daily Observation - Tax Returns

Today's Observation is not really an observation per se, but more of a lesson that needs to be shared with borrower's of all types. I was recently asked to present to a group of business brokers my take on financing and what advice I could share with them to have a more successful career.

After talking to them for about an hour about the basics of financing including the 5C's +E, if you don't know what I am referring to please e-mail and I will be delighted to share this information. I stressed the importance of looking and studying the tax returns. For the sale of a business the purchase price is derived at by looking at the returns to determine the sellers discretionary cash flow plus either inventory or FF&E. The above is a gross generalization as each business has a separate formula that needs to be applied to ascertain its real value. But the important point was that it is the tax returns that will prove or disprove that value.

Investors and sellers have to realize if they do not reflect what the true income of a project is, they will lose out and not get the proper valuation for their investment that they are trying to sell. So either pay less money in taxes and have a lower sales price or pay your actual taxes by reflecting what you are really earning and get a larger valuation for your business.

With the actual income reported in the tax returns it becomes an easier task for the bank to determine if they will lend against the property, as they can compare tax earnings over the last couple of years to calculate the Debt Service Coverage Ratio which is the most important ratio a bank will analyze when making a loan determination. Stronger tax returns always equals a higher probability of getting a deal funded.

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