Kishen Patel
Founder, Consult EFC | ICAEW Chartered Accountant
Kishen helps UK business owners achieve fundraising readiness before entering high-stakes M&A conversations. He specialises in identifying financial gaps early so that founders can protect their valuation and maintain leverage throughout the due diligence process.
Table of Contents
If you are preparing for a critical investment or a high-value business exit, your balance sheet becomes more than an accounting report. It becomes a trust test.
Buyers use financial due diligence to verify three core pillars: whether the numbers are real, whether they are complete, and whether they are repeatable. When something does not add up, they do not just ask questions. They protect themselves with price chips, earn-outs, holdbacks, retentions, or in the worst cases, they stop the deal entirely.
Consequently, business valuations can swing sharply on issues that feel small inside a busy SME finance function. Below are three practical red flags that regularly reduce enterprise value in UK SME deals, why buyers care, and how to fix them before a buyer finds them.
- Unexplained Liabilities: Buyers treat unrecorded VAT, PAYE, or accruals as debt-like items that reduce your sale price pound-for-pound.
- Data Inconsistency: If bank balances or aged debtors do not tie out to the ledger, buyers assume a “data risk” and harden deal terms.
- Cash Conversion: Stagnant stock and old receivables are treated as discounts because they signal revenue that may never turn into actual cash.
- Strategic Fix: Conduct a pre-diligence review to build a clean evidence pack and agree a normalised working capital target before the buyer arrives.
Secure Your M&A Readiness Audit
Is your deal room defensible against aggressive buyer scrutiny? Spend 30 minutes with Kishen Patel to identify financial red flags and value erosion before they hit the negotiating table.
Identify unrecorded liabilities and reconciliation gaps that buyers use as leverage to chip your offer price.
Ensure your working capital and revenue recognition policies are bulletproof before the due diligence “X-ray” begins.
● Limited Capacity: 2 readiness audits remaining this month.
Red Flag 1: Unexplained Liabilities and Off-Balance Sheet Debt
Hidden or unclear liabilities are the fastest way to lose value in due diligence. Not because buyers assume you have done anything wrong, but because they assume cash will leave the business after completion.
Most buyers treat these as debt-like items. In plain terms, this means they come off the enterprise value pound for pound, just like bank debt. Even when a liability is not labelled as a loan, it still reduces what a buyer can afford to pay.
The bigger problem is timing. If a buyer discovers a liability late, the conversation shifts from “help us understand” to “what else is hidden?” This is the moment trust drops and deal terms harden. In UK SMEs, the usual culprits are ordinary rather than dramatic:
To show how these liabilities tend to appear in deals, here’s a quick guide buyers recognise straight away:
| Liability Type | Where It Often Hides | Why It Hits Deal Value |
|---|---|---|
| VAT, PAYE & Corp Tax | Future cash outflow plus penalties risk | |
| Supplier Accruals | EBITDA and working capital get restated | |
| Customer Credits | Reduces real revenue and cash conversion | |
| Leases & Hire Purchase | Changes net debt and increases fixed commitments | |
| Legal Disputes | Indemnity requests and longer legal process |
The common thread is weak bookkeeping and missing schedules, not fraud. Still, the result is the same. Buyers assume risk and pay less.
If a buyer can’t trace a liability to a clear schedule, they’ll assume the number is understated.
Why Undocumented Liabilities Act as “Price Chips”
Buyers rarely start with a single line item. Instead, they pull threads and see what unravels. They run practical checks, then tie them back to your balance sheet, your notes, and your supporting schedules.
Buyers confirm loans, overdrafts, and security arrangements. They also investigate potential covenant breaches, even if they were informally waived by your lender.
Expect a deep dive into returns, payments, and control account reconciliations. Buyers will search for outstanding payment plans or historic correspondence with HMRC.
The team will test whether your creditors listing matches actual payments made after the period end. This is where missing supplier invoices are most frequently discovered.
Solicitors are consulted regarding claims, disputes, and contingent liabilities. Broad claims that an issue is “not material” will be rejected without clear documentary evidence.
Every contract is listed and reconciled against your accounts. Any “off book” commitment discovered here usually becomes an immediate negotiation point for the buyer.
Minutes often reveal agreed bonuses, future capital commitments, or disputes that never reached the ledger but impact the future cash flow of the business.
This is where vague balance sheet labels become expensive. A line called “other creditors” or “accruals” with no breakdown invites deeper testing. Deeper testing costs time, raises fees, and usually ends in a value adjustment.
Preparing Your Liabilities for a Financial Due Diligence Review
You don’t need perfection. You need clarity, evidence, and a story that holds together under pressure.
When sellers don’t fix this, deals rarely “just carry on”. Common outcomes include a price reduction, an escrow or retention, special indemnities, or a longer exclusivity period with more scrutiny and more requests.
Red Flag 2: Inconsistent Financial Data and Broken Balance Sheet Tie-out
Inconsistency is a trust problem. A buyer can cope with a tough year if the numbers are solid. On the other hand, even a growing business looks risky when basic tie-outs fail.
The symptoms are familiar in busy SMEs: cash does not match bank statements, trade debtors do not match the aged debtor report, or fixed assets exist on the balance sheet but nobody can produce a fixed asset register.
Here’s the harsh truth buyers live by: if the basics don’t match, they assume there are more problems. As a result, they increase testing, widen sample sizes, and stop relying on management numbers. That slows the deal and can trigger a valuation haircut.
It also hits you in soft costs. Timelines stretch, management time disappears into Q&A, and professional fees rise. Even if the deal completes, buyers often push for completion accounts protections, tighter definitions of net debt, and a lower price to reflect “data risk”.
Critical Accounting Tie-outs for Business Sale Readiness in Week 1
Most due diligence teams start with a short list of tie-outs. These are simple checks designed to confirm whether your balance sheet is a reliable snapshot.
That’s how good businesses end up negotiating from a weaker position. Not because performance is poor, but because the evidence is thin.
Building an Evidence Pack to Protect Your Business Valuation
Founders often think they need a 60-page report to prepare for due diligence. They do not. What buyers want is a clean trail from the balance sheet to the proof. A lightweight evidence pack should include:
This pack changes the tone of due diligence. Instead of “prove it”, you get “confirm it”. That saves weeks.
If you want an external set of eyes before the buyer arrives, Consult EFC can run a pre-diligence review and clean-up. It’s often the fastest way to remove doubt without turning your finance team inside out.
Red Flag 3: Non-Cash Assets and Overstated Working Capital
Buyers do not buy profit. They buy cash flow or the clear path to it. Consequently, they focus hard on cash conversion. Two balance sheet areas cause repeated pain for SMEs: inventory and trade debtors. Both can look healthy on paper while hiding slow-moving items or optimistic assumptions.
Stock Valuation Risks and Potential Deal Price Reductions
Inventory is often the largest working capital item in product businesses. Common warning signs include old items carried at full cost, missing stock counts, or inconsistent costing methods.
When a buyer pushes through a write-down, deal value drops directly. A £120,000 write-down is often treated as £120,000 less value. Even worse, stock issues can turn into an argument about the “right” normal level of working capital, which drags on long after completion.
Trade Debtors and Cash Conversion Red Flags
A messy debtor book suggests disputes, weak billing, and stretched cash. Red flags include large old debts, heavy reliance on one customer, or frequent credit notes.
The fix is practical: tighten credit control and chase older debts early. Put a realistic bad debt provision through the accounts rather than defending the undefendable. Clean up related party positions and document dispute status clearly so it does not look like a surprise.
Protecting Your Enterprise Value Before an Exit
iabilities you cannot explain, numbers that do not tie out, and assets that will not turn into cash are the three balance sheet issues that most often destroy value in due diligence. Each one creates the same reaction: less trust, more testing, and tougher deal terms.
Before you go to market, keep it simple. Conduct a pre-diligence balance sheet review, reconcile key control accounts, and build clear schedules.
If you want an external set of eyes before the buyer arrives, Consult EFC can run a pre-diligence review and clean-up. This is often the fastest way to remove doubt without turning your finance team inside out.
Secure Your M&A Readiness Audit
Is your deal room defensible against aggressive buyer scrutiny? Spend 30 minutes with Kishen Patel to identify financial red flags and value erosion before they hit the negotiating table.
Identify unrecorded liabilities and reconciliation gaps that buyers use as leverage to chip your offer price.
Ensure your working capital and revenue recognition policies are bulletproof before the due diligence “X-ray” begins.
● Limited Capacity: 2 readiness audits remaining this month.
Why do buyers focus on the balance sheet rather than just the P&L?
The P&L shows performance, but the balance sheet shows the health of the assets and the reality of the cash. Any “leakage” found on the balance sheet usually results in a direct reduction of the purchase price.
What is a “Price Chip” in a business sale?
A price chip is a downward adjustment to the agreed offer price, often triggered when due diligence reveals risks, overstated assets, or undisclosed liabilities.
How can I prepare my SME for financial due diligence?
The most effective way is to perform a “dry run” or pre-diligence review. This identifies red flags early, allowing you to fix them or present them with a clear explanation before the buyer discovers them.
