How are Accounts Receivables Handled in a Business Sale?

How are Accounts Receivables Handled in a Business Sale? | Accounting Smarts
Charles Hall

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Charles Hall

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March 1, 2021

Accounts receivable is an asset included on the balance sheet and represents credit sales that have not yet been fully settled.

Accounts receivable is an asset included on the balance sheet and represents credit sales that have not yet been fully settled. Most businesses extend credit sales to their customers for customer convenience and to increase sales.  Accounts receivables are typically converted to cash within 30 to 60 days and rarely longer than one year. While older receivables may exist their value decreases with time since the longer you are owed an amount, the less likely you are going to receive it.

So, how are these accounts receivables handled in a business sale? In most cases, if the business is small, the seller keeps any cash and accounts receivable balances.  In addition, the seller retains and settles any accounts payable in order to deliver the business unencumbered to the buyer.  This allows a new owner a fresh start.

However, if the business is large, the buyer will most likely acquire the cash and receivables from the seller for use as working capital.  All this said, every transaction is independent and based on the buyer and the seller and therefore, may be handled differently regardless whether the transaction is large or small.

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Why are accounts receivables excluded in small business sales?

Why are accounts receivables excluded from a small business sale is a great question, given it happens in most small business sale transactions.  It might seem something is being left on the table.  In reality, the purchase price is rarely determined on the value of the individual assets; rather, it is most often calculated based on a multiple times some financial performance measure such as adjusted cash flow.

Here are a few other reasons accounts receivables are excluded on small business sale transactions:

  1. the multiple would be inflated.
  2. the buyers return would be less.
  3. the buyer would also be forced to take and collect the accounts payable.

In small transactions it is best (right or wrong) to leave these short-term assets and liabilities for the seller to handle and resolve.  This approach provides a clean break for the buyer.

A reason a buyer may want to include the accounts receivables would be to provide working capital in the short run.  In this case, the buy may want to negotiate only the most current receivables to ensure the likelihood of collection.

What is better: an asset sale or a stock sale of your small business?

There is much more to consider in the sale of a business than just how to handle accounts receivables.  The most important question is, is it better to sell the assets of the business or the stock of the business?

There are two types of business sale transactions:  asset sale or stock sale.

So, which one is better?

The answer isn’t so simple.  The best answer is to understand both types and then decide based on your situation and the pros and cons of each.

However, if you are a sole proprietor or partnership the only option for selling your business is an asset sale.  This can prove challenging as often the only real asset of a sole proprietorship is the skills and experience of the owner.

Let’s look at each type of sale to fully understand the differences.

Asset Sale

An asset sale is when a company sells some or all of its tangible or intangible assets.

  • Tangible assets include cash, accounts receivables, inventory, equipment or buildings.  Tangible assets are the physical items in a business that are typically easy to value.
  • Intangible assets include goodwill, patents, trademarks, customer lists, and even the business name.  Intangible assets are typically nonphysical items in a business that are very difficult to value.

A buyer and a seller may differ greatly on an intangible assets value.  So, as the seller you must prove its value.  Because of this, it is wise to consult a professional to handle these types of complications regarding the sale of the business.

Because you are purchasing only assets in an asset sale, once the total purchase price has been agreed upon, each asset must be assigned a value.  The total of all purchased assets must then equal the purchase price.

Additionally, because you are only purchasing assets, the seller retains ownership of the business and all remaining assets and liabilities.

Stock Sale

A stock sale entails purchasing ownership in the legal entity of the seller. As mentioned above this option is only available when selling an incorporated business.  Since you are buying the legal entity rather than just assets, everything including cash, receivables, liabilities and all intangible assets are included.  The seller no longer has ownership of the business.

If certain assets or liabilities are not wanted in the transaction, they are collected, paid for or sold prior to the sale transaction.

Unlike an asset sale, in a stock sale, assets are not valued because you are buying the entity as is rather than breaking it apart into purchasable assets.

Summary of the difference between an asset and stock sale

Asset Sale Stock Sale
Any business can use this method Only an incorporated business can use this method
Can separate assets, and purchase only what you want including both tangible and intangible assets Cannot separate assets, must purchase the entire company including all assets and all liabilities.
Liabilities are not included in the sale Liabilities are included in the sale
Most common for small business and partnerships More common for large corporations

What are the tax implications of selling a small business?

The most important aspect of any small business sale is the tax implications.  You could sell your business and literally pocket only half of the proceeds due to tax implications.  For this reason alone, it is wise to seek advice and consultation from a tax professional.  Typically, the buyer and the seller have opposing tax benefits, meaning what is good for one is not good for the other.  Because of this it is important to really understand the tax consequences when making selling decisions.

The following decisions, among others, are first and foremost in determining your tax consequences.

  1. Entity type (sole proprietor, partnership, LLC, S-corp, corporation)
  2. Sale type (asset sale or stock sale)
  3. Allocation of purchase price between capital and noncapital assets
  4. Installment sales vs upfront payment
  5. State and local taxes
  6. Estate planning

These topics are mentioned here, without discussion, for the sole purpose of making you aware that there is more to the sale of a small business than finding a buyer, including or not including accounts receivable, and pocketing the sale proceeds.

Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall