Purchasing an existing high end retail business and need quick advice.

[JN112x]

I am currently in the process of purchasing the company I currently work for. We are two weeks form the closing and I am not exactly sure how we are going to
handle the existing sales. Here is how a sale typically transpires:

1. Customer places order
2. A sales order is generated
3. A deposit is applied to the sales order
4. Product is ordered from vendor
5. It arrives weeks sometimes months later
6. Vendor invoice arrives and is paid (with deposit money)
7. Items are delivered or installed
8. Customer pays balance of order

We have a few hundred thousand in open orders, all at varying stages of the process. Most of the sales have product that has not yet arrived that we have
collected deposits on. Here are my questions:

1. If the sale has been made but the product is not in yet, shouldn't I get the deposit even though it was technically his sale? I am going to have to follow it
through to completion on my dime.

2. If the sale has been made, the product has arrived, vendor has been paid, customer has not yet paid the balance. What happens here?

I have an accountant and a lawyer but they both charge an arm and a leg and I was hoping to give them some ideas so they dont waste time proposing idea that I have already thought of.

Thanks for the input.
Jeff

[Paul]

Sounds like a furniture store. Is it? I'm very familiar with that business.

Item 1) The deposit money is technically a liability, the money is “owed” to the customer until the transaction is complete. In other words, from a bookkeeping perspective, it’s not really the company’s money yet. It hasn’t been earned from the customer.

Item 2) Similar to item 1 except that now the ‘deposit” is essentially in the form of inventory. However, It is still owed to the customer.
The deposits and the inventory should stay with you.

The real question is about the “profit” that will be realized when you complete the sales. Theoretically, those profits may belong to the seller, depending on the terms of your purchase agreement.

A financial statement won’t reflect the above in the way it is described, in that it won’t be detailed item by item and customer by customer. But it should be fairly easy to figure out what the profit will be. You may need to pay that.

[huggytree]

why are you asking us?

it sounds like something that should have been part of the price you paid for the business

i assume the asking price was adjusted for orders already placed????

[dave@businessecon.org]

This is where you need to use ACCRUAL ACCOUNTING. If done with this, the exact amount of this issue is known to the minute of the closing.

Dave

[ArcSine]

JN112x, there are no standardized rules which cover the handling of these types of issues at closing. Recognize them as discrete pieces of cash flows which can be allocated between the parties in whatever manner best suits their respective financial circumstances. How they're allocated is a matter of negotiation and agreement.

For example, it would certainly make sense for the sake of simplicity to allow customer deposits to be retained with the business, to be used for vendor payments when the product arrives. Then the customer's subsequent remainder-upon-completion payment, which roughly represents the gross profit on the job, could either be retained by you (with a commensurate increase in the price you pay for the biz), or remitted to the seller. As with any other set of trade receivables existing at the time a business changes hands, the buyer can either "purchase" the receivables or allow the seller to keep 'em and collect 'em himself. Either way, the purchase price is adjusted accordingly.

More often than not it's just a "six of one, half pound of another" thing. Suppose for instance Buyer and Seller agree that $10K of pre-existing receivables will stay with the biz, and hence become part of the assets purchased by Buyer. So Buyer adds an additional $10K to the buyout price, but then is reimbursed, in effect, within a few weeks as he collects those receivables.

Hence it usually comes down to a matter of practicality. Suppose you're getting a new working capital credit line established for the company, but it won't be in place until some 7 weeks or so after you've bought the biz. So you might wanna let the seller keep the receivables, thereby reducing your out-of-pocket buyout price at closing, and then the proceeds from the new credit line in a couple of months makes up for the fact that those receivables won't be generating any cash flow for you as those customers remit.

So whether you buy those existing receivables or not depends on things like your own cash flow position over the next couple of months, what kind of financing and credit lines you might have available (both at closing and post-deal), and what likelihood you assign to the collectibility of the AR (the more questionable they are, the more I'm inclined to let Seller keep 'em).

[Business Attorney]

There is no single "right" answer. ArcSine overall approach is certainly one way to look at it. You can also look at each of the 8 steps as different stages of the process that each need their own approach. For example, a sale that is at step 1 or step 2 (largely just an administrative difference) you could owe the seller a commission of 5% on the sale. At step three, if the seller took a 20% deposit but did no other work or pay any money to a vendor, he would owe you the 20% deposit less his 5% commission. And so on for each step. At step 8, you might owe him the balance when paid, less a 2% fee for collecting and remitting the funds.

Normally, simple is better. I find that the most common result is that on steps 1-7 everything belongs to the buyer (including the deposit) and that has been taken into consideration in arriving at the purchase price of the business. For things at step 8, it is pretty much split on whether it all goes to the seller or all goes to the buyer, but again it has been negotiated and considered as part of the purchase price. If the seller assumed he was keeping the receivables and the buyer assumed he was getting the receivables, that is usually a pretty significant item to have fallen through the cracks in the negotiations.

[Zman]

I agree with Business Attorney in that most vendors are net 15 at minimum, with net 30 or 45 being more common so I doubt any monies given to the seller as a deposit have been paid to the vendors. But I would have made it part of the negotiating process or it could put you in a bad spot if the seller keeps the deposits and you have to collect the balance and pay the vendors. The good news is, hopefully in that scenario at least you should break even depending on your margin. However, if you have to deal with some cancellations, as all order businesses do, you could get hung with the cancelled inventory, be responsible for the vendor payment, and the seller would have kept the deposit. And... you might have to refund a portion of the deposit to the customer who cancelled the order.

I might spend that "arm and a leg" and get the accountant and attorney involved... it could end up being money will spent.