Whether you plan to sell your business to family, employees, or outsiders, you must present clean, accurate financial statements to potential buyers.

There are 12 common financial statement mistakes to avoid. Last month, I discussed the first three: operating on a cash basis instead of accrual, mismatched profit and loss statement and balance sheet dates, and an unbalanced balance sheet. This month, I'll cover the next mistake. To present your company well, ensure your financial statements show growing profitability.

Mistake #4: Negative Gross Profit

A negative gross profit means you’re selling items for less than their cost.

For example, a client once told me, "We lost $80,000 this month; we’re going out of business." They hadn’t actually lost that money. The loss appeared because they ordered materials for a large job that hadn’t started yet. The materials were incorrectly categorized as cost of goods sold instead of inventory, leading to a false loss on the profit and loss statement.

Another common issue: "We’re busy, but we’re losing money." Both situations arise from what I call "financial statement fruit salad."

What is Financial Statement Fruit Salad?

Financial statement fruit salad happens when revenues and expenses don’t match in the same month. This often results from a lazy bookkeeper. The only time you might see a negative gross profit is if your company only did warranty calls and callbacks in a month, with little or no revenue but significant labor and material expenses.

If revenues are recorded in one month and the expenses for those revenues are recorded in another, you end up with fruit salad (apples and oranges) on your profit and loss statement. This mismatching is disastrous. Revenues must match expenses in the same month to ensure accurate financial decisions.

If your bookkeeper separates revenues and expenses across different months, you’re misleading yourself. The month with revenues but no expenses will look profitable, giving you a false sense of security. The month with expenses but no revenues will show a loss, making you unnecessarily worried. Neither scenario reflects reality.

Lazy bookkeepers might close the month without ensuring all revenues and expenses match. They might also misclassify materials ordered for jobs as cost of goods sold without recording the corresponding revenues.

A common reason for being busy but losing money is improper accounting for maintenance sales.

Example:

Mrs. Jones pays for a maintenance agreement in January, which you record as a January sale. You perform the first check in April and the second in October.

In January, you have revenue with no matching expenses. In April and October, you have expenses with no matching revenue. This creates financial statement fruit salad, where January’s profit and loss looks better than it should, and April and October look worse.

Seasonality can skew your financial statements. Even in slow months, your gross margin should remain consistent. With properly accounted recurring revenue, your company should at least break even in slower months.

A positive gross profit is normal. Ensure your bookkeeper isn’t creating fruit salad in your financial statements.

Ruth King has over 25 years of experience in the HVACR industry, helping contractors, distributors, and manufacturers grow their businesses and increase profitability. Contact Ruth at ruthking@hvacchannel.tv or 770-729-0258.