Why it matters
In cash-heavy trades such as cafés, bars, salons, car washes and market stalls, a seller will sometimes say the business earns more than its accounts show, because some cash takings never reach the books. The suggestion that follows is that you should pay for that income too.
Do not. Income that is not recorded cannot be verified, will not count with a lender, and in most cases has not been declared for tax. Paying for it means paying for a story. Relying on it after you buy would mean carrying on the same practice yourself.
There are two further risks. The first is tax. Undeclared income can lead to assessments, interest and penalties, and in a share sale those stay with the company you have bought. Buying the assets rather than the shares usually leaves historic tax with the seller, although in some jurisdictions certain tax debts can pass to the buyer of a business's assets, so take advice from a qualified accountant or lawyer before going further. The second risk is the seller. Someone who has been relaxed about what the tax authority sees may be equally relaxed about what you see.
The practical treatment is to value the business only on recorded, declared earnings and to give unrecorded cash no value at all. If the seller will not accept a price built on those figures, treat it as a deal breaker.
In an asset sale you buy selected assets of a business; in a share sale (a stock sale in the US) you buy the company itself, with its full history. The choice shapes risk, tax and what needs consent.
How to spot it
Sellers rarely put it in a listing. It usually comes up in conversation, as a hint that the books do not tell the whole story. Other signs:
- Recorded sales look low for the seating, opening hours, footfall or number of staff.
- Purchases of stock and supplies are high relative to recorded sales, so gross margin looks unusually thin.
- Cash deposits at the bank are rare or irregular in a business where many customers pay cash.
- Card takings make up almost all recorded revenue, although customers often pay in cash.
- Some staff are paid in cash, or wage costs look too low for the rota.
- Till reports and the accounts do not agree.
Gross margin is revenue minus the direct cost of what a business sells, shown as a percentage of revenue. It shows how much each sale contributes towards overheads and profit.
Questions to ask the seller
- How are cash takings handled from the till to the bank, and who handles them?
- Are all sales, cash and card, recorded in the till system and in the accounts?
- Why are purchases so high compared with recorded sales?
- Are any staff paid in cash or outside the payroll?
- Would you accept a price based only on the figures in the filed accounts and tax returns?
- Has the business ever been subject to a tax enquiry or investigation?
Documents to request
- End-of-day till reports for the last 12 to 24 months
- Bank statements showing cash deposits for the same period
- Card processor statements
- Supplier invoices and the purchase ledger
- Payroll records and staff rotas
- Filed tax returns and VAT or sales tax returns