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I recently had the privilege of joining Bob Tankesley on the Exit Teams Podcast — Bob is the author of Exit Teams: Build a Team of Advisors for Your Business Sale to Get a Higher Price, and the show is a fantastic resource for business owners preparing for a transaction. Our conversation focused on something that has become a day-to-day conversation for me: the critical role that financial statement auditing plays in a successful business sale, particularly for manufacturers and distributors.
I want to share the key takeaways from the podcast here, because the issues we discussed come up constantly in my work, and the stakes are high. Financial statements are one of the very first things buyers examine when considering an acquisition. They form the foundation of buyer trust — and without that trust, even a great business can struggle to command the valuation it deserves.
I'm a Partner at Brown Edwards, a top 100 regional firm with offices throughout Virginia, West Virginia, and Tennessee, and I lead our manufacturing and distribution audit practice out of our Bristol, Tennessee office. With more than twenty years of experience, I have seen firsthand what separates businesses that sail through due diligence from those that don't. Here's what I want every small to mid-sized manufacturing and distribution business – or any other for-profit business owner to know.
1. The Most Common Audit Deficiencies in Manufacturing Businesses
When I work with manufacturing or industrial businesses that are preparing for a sale — or that find themselves in the middle of one — there are three areas where I see deficiencies most consistently.
A Strong Month-End Closing Process
Small accounting departments are the norm in our region, and the reality is that one person can only do so much. Segregation of duties is a challenge and this is a reality for many companies. However, the focus on a systematic monthly closing process should not be compromised
Sometimes, companies keep their internal books and records on a cash basis. Buyers want GAAP-basis financial statements, and I have only seen GAAP basis financial statements required for larger deal closings. If you're running a twenty-, thirty-, or forty-million-dollar revenue business and you're still on cash basis, you may need to make that switch — the sooner the better. Or at least have a conversation about what differences may exist and how impactful that may be.
On GAAP basis, the fundamentals have to be right: accounts receivable recorded properly, accounts payable recorded properly, and depreciation running correctly. But the items that are often omitted are prepaid expense amortization, warranty accruals, and accounts receivable reserves (that honestly reflect the collectability of your outstanding invoices in today's economic environment).
Tight Inventory Controls
Inventory is an area I could talk about for the rest of the conversation — and on the podcast, nearly did! It's where most manufacturers have the greatest exposure.
The questions buyers and auditors ask are simple:
- Does all of this inventory exist?
- Is all of it sellable?
- Do you have a reliable perpetual list?
- Are quantities supportable by SKUs and item details?
- And critically: how is it costed?
Not long ago, I was approached to audit a company preparing to go to market that had not performed an inventory observation in two years. As a result, some items on their list didn't physically exist. We had to count by weight, by unit, and by length — and then work through costing for every item. Under GAAP, manufacturers are required to apply overhead rates as product moves through the production process. If that isn't being done correctly, your margin numbers may not be reliable, and sophisticated buyers will find that quickly.
Estimates
Warranty liabilities, AR reserves, and other accruals are areas where manufacturing companies frequently fall short. These figures require input from people outside of accounting — like production and operations — which means finance and operations need to be in regular and frequent communication. Are you building a supportable warranty liability estimate? Are your receivable reserves reflecting real-world conditions? These aren't just audit questions. They are exactly the questions buyers will ask.
2. How Far in Advance Should You Engage an Auditor?
My recommendation is two to three years before you expect to go to market. Bob has landed on that same timeframe from his perspective as an M&A advisor, and I think for good reason.
Auditors and buyers alike look at beginning balances, year-over-year fluctuations, and margin trends. You need that data — and it needs to be correct and reliable — in order to build a credible financial history. If you try to get this cleaned up right in the middle of a deal, it's daunting, and it can genuinely derail a transaction.
There is one practical measure I recommend for manufacturers who want to build a strong inventory baseline: implement cycle counts after you've completed a thorough physical inventory count. Cycle counts put responsibility on production personnel, who then become more accountable for reporting scrap, tracking receipts, and recording usage correctly throughout the year. It also keeps accounting involved at the right level by distributing the work across months and quarters rather than creating a scramble at year-end.
3. What Does a Financial Statement Audit Actually Looks Like
"Audit" is a word that makes a lot of business owners nervous. I want to be straightforward about this: an audit is not meant to be a “gotcha moment”. It's meant to implement diligence and best practices. The goal is simply to verify that your numbers are supportable.
When an audit opinion is issued on top of your financial statements and you hand it to a prospective buyer, it communicates immediately that your numbers are materially reliable. That is an invaluable first impression.
4. Quality of Earnings vs. Financial Statement Audit: What's the Difference?
Bob raised the topic of Quality of Earnings (Q of E) reports, which buyers increasingly request and which more sellers are commissioning on a sell-side basis to get ahead of due diligence. Here's how I distinguish the difference between Q of E reports and audits.
A Q of E report does not verify the underlying data the way an audit does. The Q of E team won't be tying your numbers back to invoices or registers. However, the process can feel quite similar to an audit in terms of depth and questioning.
Another key difference: financial statement audits are typically annual. Q of E reports can include data that is either monthly or quarterly, giving buyers a more granular, forward-looking view — what the business looks like on a month-by-month basis, which segments are profitable, and whether the revenue stream is sustainable. The audit confirms the numbers are correct (typically looking at historical data); the Q of E examines what those numbers mean for future earnings potential.
Both serve important purposes. Q of E reports help buyers understand a business faster and with more nuance. The audit provides the foundational reliability that makes that analysis meaningful.
5. Red Flags That Raise Concern During Due Diligence
Private equity groups and strategic buyers bring full teams of analysts to perform due diligence procedures. They are very good at identifying risk quickly. Here are the financial red flags that tend to raise the most concern:
Inconsistencies in the Data
If your numbers don't tell a consistent story across time periods, buyers will notice. I was involved not long ago in work that began as an opening balance sheet compilation and turned into a full audit. Overnight, the margins had changed because the inventory costing methods had changed. That kind of unexplained fluctuation forces buyers to start asking harder questions, and it erodes confidence quickly.
Inventory Problems
Inventory issues can often shine light on issues very quickly. If your inventory costing is unreliable, your margin numbers are unreliable — and margin is one of the first things sophisticated buyers will examine.
Tax and Regulatory Exposure
Tax red flags can include nexus issues across states, transfer pricing concerns, and other potential regulatory liabilities. Some tax situations also represent an opportunity, like a cost segregation study. Either way, buyers will look at them closely and consult their own advisory teams.
Revenue Cutoff Issues
For manufacturers shipping products, the question of whether revenue is recorded in the right period matters greatly. For companies with high volumes of smaller transactions, this can get complicated quickly. Your audit should provide confidence that your revenue figure is accurate and defensible.
6. Improvements That Build Buyer Confidence Over a Two-to-Three-Year Runway
When Bob asked what kinds of improvements can be made over a two-to-three-year window to impress sophisticated buyers, here's what I shared:
Clean up your books and records. Are your subledgers doing the heavy lifting, or are there a lot of manual entries and backside corrections required to get your books right? PE firms and strategic buyers can spot a hard process versus a smart process almost immediately — and they will price inefficiency into their offer.
Organize your property and inventory. Does your facility look organized? Scrap and waste sitting around may send a signal about the operational quality of the whole business.
Develop supportable estimates and document everything. If you have a large related-party receivable, make sure you have a written agreement in place. If you have warranty liabilities, make sure they're documented and supported. I once worked with a company that had a multi-million dollar related-party receivable with no agreement behind it. We flagged it in the audit, and within three months, they had it fully papered. It’s just a good practice.
Track adjusted EBITDA. If you have one-time or non-operating costs — a legal fee, a recruiting fee, or something that isn't part of running the normal course of business — track those separately. They can be reported below the line as add-backs, supporting a higher adjusted EBITDA number that buyers may give you credit for.
The bottom line: PE groups know how to cut costs and optimize processes. If they can see that your operations are harder than they need to be, they're already calculating how to fix it — and they'll reduce their offer accordingly. Use the runway to implement those improvements yourself and capture that value in your multiple.
7. The Importance of an Aligned Advisory Team
On the podcast, Bob and I talked at length about the value of having your full advisory team — CPA, attorney, banker, and M&A advisor — working together rather than in silos. I can't emphasize this enough.
There should be no secrets between your advisors. We all work for you, the client, and our collective goal is to get you the best possible outcome. That means open, honest conversations early about where the likely pressure points will be in due diligence. Bob brings an especially valuable perspective here: when an M&A advisor takes a company to market, they hear from ten, fifteen, or more potential buyers. That means they know exactly where buyers are going to push back. That intelligence should flow to your auditor so we can get ahead of those issues — not be caught off guard by them.
Areas where advisory team alignment is especially important:
Customer concentrations: Who are the major customers driving revenue, and what's the risk profile of that dependency?
CapEx needs: What does the future capital expenditure picture look like for the business?
Vendor and employee relationships: Key relationships that could be affected by a change in ownership need to be disclosed and discussed proactively — not discovered during due diligence.
Bonus structures: Buyers typically don't want to see large bonuses paid out in the year before a deal closes. Aligning on how employees will be taken care of at closing is an important part of the deal planning process.
Tax credit opportunities: Are there planning strategies that can benefit the seller or make the company more attractive to buyers?
The theme throughout all of this is transparency — early and often. Buyers will find the issues. The only question is whether you find them first.
8. Audit Readiness Is Not Just Compliance — It's a Value Driver
I want to close with what I believe is the most important reframe in this entire conversation. Too many owners think of audit readiness as a compliance burden — something they have to endure. I see it very differently.
An audit is not meant to be backward-facing forever. Yes, initially it's going to look at what's already happened. But once you get into the rhythm of an annual audit, it becomes forward-thinking. It creates discipline throughout the organization. It catches issues — a prepaid insurance balance that's been sitting on the books since 2022 and was never expensed off, old outstanding checks that should have been turned over, lease agreements that production personnel entered into without accounting ever seeing them. These are real examples from real clients.
When your auditor catches those things, you have time to fix them. When a buyer's due diligence team catches them, those same issues become negotiating leverage against you.
"An audit doesn't always just have to be a terrible thing. If you can discipline yourself to think about ‘how can I make my books internally better to make my audit run better’, that's going to be advantageous when you're thinking about a sale."
That's something I said on Bob's show, and I mean it. The habits you build through the audit process — a strong monthly closing process, regular inventory reconciliation, documented estimates, clean related-party transactions — are the same habits that will impress buyers and maximize your sale price.
Final Thoughts
If you run a manufacturing or distribution company and you're thinking about a sale — whether that's two years away or five — now is the time to start getting your financial house in order. The buyers you want to attract are sophisticated. They have seen thousands of companies. They will find the problems in your financials. The question is whether those problems surface as issues you've already addressed, or as reasons to lower their offer.
I'd welcome the opportunity to talk through where your business stands today and what steps would make the most difference. You can find me on our website at www.becpas.com under the manufacturing and distribution practice area, where you'll find my direct contact information. Please don't hesitate to reach out.
And I'd encourage you to check out Bob Tankesley's Exit Teams Podcast and his book, Exit Teams: Build a Team of Advisors for Your Business Sale to Get a Higher Price, available on Amazon, and at ExitTeams.com. Bob's perspective on building a collaborative advisory team around a business owner is exactly right — and this blog post grew directly out of our conversation on his show.
About the Author
Megan Meador is a Partner at Brown Edwards and leads the firm's manufacturing and distribution audit practice out of the Bristol, Tennessee office. She has over twenty years of experience in public accounting and the private sector, including assurance services at a national top-five firm and controllership roles at a publicly traded coal company. Her focus at Brown Edwards is audit, assurance, and consulting within manufacturing, mining, and energy.
Originally featured on the Exit Teams Podcast with host Bob Tankesley.
Exit Teams: Build a Team of Advisors for Your Business Sale to Get a Higher Price — available on Amazon and at ExitTeams.com.
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