Cleaning-up Your Balance Sheet

The following comments are taken from a recent post to a list serv to which I subscribe. It occurred to me that there might be a wider audience for these comments and thus they are posted below.

During the course of some recent valuations I noticed a couple of things regarding balance sheets that bothered me.

In one situation the owner (either in the beginning or in recent years) had loaned the company money, and thus this loan now shows up as a long-term liability. That's not unusual or bad by itself - It happens all the time. However, the problems with this loan, as I view it, were really two-fold:

• First, it decreases the net worth of the company on your balance sheet and it is very, very unlikely that it will be an item that will ever be recaptured during the future sale of the business. These types of loans are rarely ever cleaned off the balance sheet, and even CPAs and accountants rarely even mention these types of loans. Remember, if and when you ever sell the typical buyer is not going to be willing to pay off debts you should have taken care off long before the settlement.
• The second concern is an issue of taxation and that is: Given the choice of paying yourself a paycheck of say $5,000 or paying down the company's $5,000 note that it owes you the latter would be preferable since it is not subject to FICA and other payroll taxes, since it is the repayment of a loan. Not only do you save in taxes but your books are cleaned up as well. Of course, ideally, you would like to do both (take a paycheck and have the company pay off its note to you) but if you could only do one or the other (unless you have unlimited cash of course) paying off a company note to you would be the better move, at least in my opinion.
  

By the way, during the course of one recent valuation, even after deducting some of these personal loans made by the owner to his company, the company balance sheet still showed a negative net worth of $(75,000). Despite dismal numbers both on his balance sheet and and his profit and loss statements, the owner was adamant about not even wanting to discuss any offers under $100,000! Amazing. This owner is living in a dreamworld. For the past 5-6 years, this owner has been paying himself a salary equivalent to approximately $14-17 per hour and after that the company showed virtually no profit whatsoever. Simply put, no profit (excess earnings) no value. It is almost as simple as that!