At this size lenders size an acquisition on the target's year-end financial statements, ideally reviewed or audited, as adjusted and tested in a quality of earnings report. The tax returns are the cross-check. Differences are normal: accrual books against cash-basis returns, tax depreciation, year-end adjustments, entities that file separately, owner costs. A documented reconciliation lets lenders keep the earnings. A gap nobody can explain becomes a question about every other number in the file, and income that was never reported is never counted.
- What lenders size on
- Year-end statements, adjusted and tested in a quality of earnings
- What the returns are for
- A cross-check that the statements are real
- Legitimate differences
- Kept, when reconciled line by line with support
- Unreported income
- Not counted by any lender, whatever the seller says
- Which year
- The target's latest full year of figures, never an older one
Why the numbers rarely agree
A company's monthly P&L, its year-end financial statements and its tax return are prepared for different readers. The monthly books are closed by the finance team to run the company. The year-end statements are adjusted by an outside accountant, and at this size often reviewed or audited, to present the year fairly. The return is prepared to report taxable income under tax rules, which differ from accounting rules on purpose. It would be unusual for all three to show the same bottom line.
Most differences have ordinary explanations. A few do not, and the whole exercise is about telling one kind from the other.
| Difference | What causes it | Can lenders use the earnings? |
|---|---|---|
| Accounting method | Statements on accrual, return on a cash basis, so revenue and costs land in different years | Yes, once the timing is walked from one to the other |
| Depreciation | Accelerated or bonus depreciation on the return, straight-line in the statements | Yes; depreciation is added back in either case |
| Year-end adjustments | Accruals, inventory counts, reserves and write-offs booked after the monthly close | Yes, and the adjusted figure is usually the more reliable one |
| Several entities | The statements combine companies that file separate returns, or a real estate entity sits outside | Yes, once each return is tied into the combined figure |
| Owner compensation and perks | Salary, vehicles, travel, family on payroll and insurance run through the company | Partly; each add-back needs a ledger entry and a reason |
| One-time items | A lawsuit settlement, a plant move, a failed product launch | Yes, with the document that shows it will not recur |
| Unreported income | Sales that never reached the books or the return | No |
Accounting method alone can move a year's profit a long way in a company with large receivables, inventory or work in progress. How lenders read cash and accrual statements explains why lenders want accrual for the operating picture while still tying back to the return.
The figure lenders actually size on
Senior cash-flow lenders size on adjusted EBITDA, and they want it built from the best statements the company has. Audited statements carry the most weight, reviewed statements less, and compiled or internal statements least; audited vs reviewed vs compiled sets out the difference. On most acquisitions at this size a quality of earnings report then tests the adjustments and runs a proof of cash, so lenders start from a figure an independent accountant has already worked through.
The returns stay in the file as the cross-check. A lender that sees statements showing materially more profit than the returns, with no bridge between them, will ask which version is real before it asks anything else. The direction of the gap matters. When the statements show more than the return, lenders want to see that the difference is timing, depreciation or documented add-backs, not revenue the return does not support. When the return shows more than the statements, lenders ask what the books are missing, because statements that understate profit usually mean the close is incomplete, and incomplete books make every monthly figure after closing harder to trust.
Lenders do not average the versions. They start from the best statements, test them, and tie them back to what was reported.
Unreported income: why the answer is always no
Occasionally a seller tells buyers the company earns more than it reports, and asks to be paid for it. No lender will count that income, and there are several reasons beyond the obvious one.
- It cannot be verified. A seller's statement or a spreadsheet is not evidence of income. The lender needs a document that someone other than the seller stands behind.
- It is a tax liability. Income left off a return is tax owed. In a stock purchase that exposure travels with the company to the buyer; even in an asset purchase, the lender does not want its borrower built on it.
- It may not survive the sale. Revenue that never reached the books cannot be traced to customers, so no one can show it will keep coming under a new owner.
- Lenders cannot be party to it. A credit file that counts unreported income is a file no lender can defend to its own credit committee or investors.
The practical consequence is about price, not paperwork. If the asking price is built on income no lender will fund, the difference has to come from the buyer's equity or from the seller, and a seller note is debt that has to be serviced from the same reported cash flow. Buyers who negotiate the price down to what the verified earnings support rarely regret it. Paying for income that cannot be proven is one of the common paths to an acquisition loan being declined late in the process.
How to build a reconciliation lenders will accept
A reconciliation is a bridge. It starts from a number that can be verified and walks line by line to the adjusted EBITDA the buyer is relying on. Each step carries the document that proves it. Here is the shape of one, in plain numbers:
| Step | Amount | Support lenders will ask for |
|---|---|---|
| Taxable income per the combined returns | 3,050 | The filed returns for each entity |
| Add: book-to-tax differences (accrual timing, tax depreciation) | 250 | The accountant's book-to-tax reconciliation, with receivable, payable and fixed-asset roll-forwards |
| Net income per the year-end statements | 3,300 | The reviewed or audited statements |
| Add: interest, taxes, depreciation and amortization | 1,400 | The statements and the fixed-asset schedule |
| Reported EBITDA | 4,700 | The sum of the lines above |
| Add: one-time legal settlement | 300 | The settlement agreement and proof it was paid |
| Add: owner compensation above market pay for the role | 250 | Payroll records and a basis for the market salary |
| Adjusted EBITDA | 5,250 | The EBITDA bridge, as tested in the quality of earnings |
Three things make a reconciliation hold up. First, it ties to documents someone other than the seller stands behind: the returns, the reviewed or audited statements, the bank statements. Second, every add-back is specific: an amount, a ledger account and a reason, not a round number labeled "owner expenses". The add-backs page covers which ones lenders accept and which they strike. Third, it does not stop at EBITDA. Lenders go on to take out maintenance capital spending and taxes to test coverage, which is where the difference between SDE and EBITDA comes in for owner-run targets.
Bank statements are the cross-check on all of it. A proof of cash compares deposits with reported revenue. Deposits well above revenue invite the unreported-income question; revenue well above deposits invites a question about receivables or the accounting basis. Either is answerable, but only if the reconciliation anticipates it.
What goes in the file
For a term loan financing an acquisition, Midas Partners's checklist for the company being bought is:
- The P&L for the latest full year, never an older year in its place, for every company being bought
- A year-to-date P&L through the last month-end
- The balance sheet
- A debt schedule, with the notes that will be paid off at closing
- An AP aging
- The letter of intent
Where a revolver or asset-based line is part of the financing, lenders add an AR aging by customer with days outstanding, an inventory report if inventory is in the borrowing base, and often two to three years of business tax returns and bank statements. The full list is on what lenders need to finance an acquisition. Whatever the list, bring the returns into the reconciliation early: lenders will ask for them, and it is better to have answered the question before they do.
How Midas Partners handles the gap
When a buyer sends a target's statements and returns, the reconciliation is built into the file before any lender sees it: the bridge from reported to adjusted EBITDA sits in the financing model, and the underwriting memo explains each adjustment and the document behind it. Software does the analyst work and a senior banker checks every page. Once the documents are in, Midas Partners builds the full lender package in a day. How we underwrite sets out the approach.
What Midas Partners will not do is take a file to lenders with figures that do not reconcile, or with an older year standing in for the latest one. A lender that finds the gap itself stops trusting the rest of the package, and the buyer rarely gets a second first impression. If the verified earnings do not support the price, that is worth knowing before the financing contingency clock runs, not after.
Common questions
- Will lenders use the seller's internal statements instead of the tax return?
- They will use the best statements available, ideally reviewed or audited year-end statements tested by a quality of earnings, and tie them back to the returns. Where the two disagree, they want every difference explained and documented.
- The seller says the company makes more than it reports. Can I borrow against that?
- No. No lender will count income that was never reported, and a price that depends on it has to be funded with the buyer's own money or renegotiated.
- Do lenders require audited statements?
- Not always. Many lenders accept reviewed statements plus a quality of earnings for an acquisition, and larger or more leveraged deals push toward audits. The credit agreement will usually require a level of reporting after closing.
- Which year do lenders use if the latest year-end statements aren't finished?
- They still want the latest full year of figures, from the internal statements, alongside the prior year's finished statements and a year-to-date P&L. An older year cannot stand in for the latest one.
- Who prepares the reconciliation?
- Often the seller's accountant, the quality of earnings provider, or the buyer's advisor. Whoever builds it, it has to tie to documents and carry support for every line, because lenders will check each one.