Buying or selling a business is a complex process that requires thorough financial due diligence. Whether you’re acquiring a company or preparing to sell, having the right financial documentation is crucial to ensuring a smooth transaction.

I’ve worked with many business buyers and sellers, and I’ve seen firsthand how deals can fall apart when financials are incomplete, disorganized, or reveal red flags too late. On the other hand, businesses with well-prepared records tend to command higher valuations and close deals faster.

This guide will walk you through:

• Key financial indicators to assess when buying a business
• Essential documents buyers should request and red flags to watch for
• How to negotiate adjustments if concerns arise
• What sellers should prepare in advance to avoid costly surprises

Buying a Business: What to Review and Request

If you’re buying a business, you must conduct thorough due diligence to ensure the numbers make sense and there are no hidden liabilities.

Key Financial Indicators to Assess

One of the most critical factors to evaluate is how the business’s financial margins compare to industry benchmarks.

For example, I recently reviewed a deal for a client in the home health care space. Initially, the 10% profit margin seemed low, but after researching industry standards, I found that 10-15% is typical for that sector. Moreover, when adjusting for the owner’s salary—since the business already had a separate CEO—the adjusted margin was at the top end of the industry range.

This kind of analysis is essential when assessing a company’s profitability and determining whether its financial performance aligns with industry norms.

Essential Documents to Request

During due diligence, buyers should request anything and everything they can get. Key financial documents include:

• Profit and Loss Statements (P&L) – Last 3 to 5 Years
• Shows revenue, expenses, and net income.
• Look for stable or growing revenue and consistent profit margins.
• Balance Sheet – Last 3 to 5 Years
• Reveals assets, liabilities, and owner’s equity.
• Watch for sudden changes in retained earnings or unexplained shifts in capital asset accounts.
• Cash Flow Statements
• Indicates how money moves in and out of the business.
• A positive operating cash flow is a must for financial health.
• Full Transaction Records
• Line-item details of revenue and expenses.
• Helps verify if reported financials are accurate.
• Payment Account Statements
• Bank and merchant processor statements.
• Ensures the numbers match what’s reported on financial statements.
• Tax Returns – Last 3 to 5 Years
• Confirms reported profits match tax filings.
• Identifies any outstanding tax liabilities.
• Contracts & Agreements
• Client contracts, vendor agreements, and lease terms.
• Helps assess long-term stability.
• Employee & Payroll Reports
• Lists staff compensation and benefits.
• Useful for assessing labor costs and potential liabilities.

Red Flags to Watch For

• Balance sheet discrepancies year over year
• Mismatches between retained earnings and net income
• Unusual capital asset account changes
• High refund percentages or excessive overhead costs
• Unfiled or unpaid state tax obligations

These issues can indicate financial mismanagement or hidden risks that could impact the business’s valuation.

How to Negotiate Adjustments for Identified Concerns

If due diligence reveals concerns, buyers should negotiate adjustments or safeguards into the deal. The most common approach is setting aside reserves to cover potential risks.

For example, if a business has unresolved tax liabilities, a portion of the purchase price can be held in escrow until the issue is resolved. Alternatively, buyers can negotiate a price reduction or request the seller to settle outstanding obligations before closing.

Selling a Business: Preparing for a Smooth Sale

If you’re planning to sell a business, preparing well in advance is critical. Many business owners wait too long to get their financials in order, leading to last-minute issues that can delay or even kill a deal.

Why Early Preparation Matters

Financials are not something to rush. A well-organized financial history builds buyer confidence and helps maximize valuation.

One of the biggest pitfalls I’ve seen for sellers is tax issues surfacing during due diligence. I’ve worked on deals where hundreds of thousands of dollars were held back from a sale simply because the seller had missed a state tax return or overlooked sales tax obligations.

The worst part? Many of these issues could have been resolved for just a few thousand dollars prior to the sale. Instead, they became major liabilities that ended up costing significantly more in negotiations.

Essential Documents to Prepare

To ensure a smooth sale, sellers should have the following documents ready:

• Profit and Loss Statements (P&L) – Last 3 to 5 Years
• Clean, well-organized financials increase buyer confidence.
• Balance Sheet – Last 3 to 5 Years
• Shows a snapshot of financial health.
• Tax Returns – At Least 3 Years
• Buyers will cross-check tax filings against reported earnings.
• Any discrepancies can raise red flags.
• Business Valuation Report
• Helps justify the asking price.
• Legal & Compliance Documents
• Up-to-date business licenses, permits, and regulatory filings.
• Address any outstanding legal matters before listing the business.
• Contracts & Agreements
• Key customer and supplier contracts provide proof of ongoing business stability.
• Employee & Payroll Records
• Buyers want transparency regarding labor costs and employment obligations.
• Debt & Loan Documentation
• Outline repayment terms and whether the buyer will assume any debt.
• Sales & Marketing Reports
• Revenue trends, customer retention rates, and acquisition costs help show growth potential.

Avoiding Tax Pitfalls When Selling

One of the most overlooked risks when selling a business is state tax compliance. I’ve seen deals derailed when buyers discover:

• Missed state tax filings
• Unpaid sales tax obligations
• Payroll tax discrepancies

A simple tax review before listing the business can help identify and resolve these issues early. In many cases, paying a few thousand dollars in back taxes or filing corrected returns can prevent hundreds of thousands of dollars from being held back in escrow.

Get the Financials Right

Whether you’re buying or selling a business, organized, accurate financial records are essential.

Buyers should conduct thorough due diligence, verify financials, and negotiate protections for identified risks. Sellers should prepare financials well in advance, resolve tax issues proactively, and ensure transparency to attract the best offers.

If you need help reviewing financial documents or structuring a tax-efficient sale, my team at Optic Tax can guide you through the process.

Have questions? Let’s talk!