If we look at a very simplistic example of overhead manipulation you may see what can be accomplished by overhead manipulation.
A business has a 10,000 sq. ft. facility that is made up of 5,000 sq. ft. of manufacturing space and 5,000 sq. ft. of office. Up until the current owner decided to sell he had been allocating 5,000 sq. ft. to his manufacturing cost and 5,000 sq. ft. to his general administration cost. The 5,000 sq. ft. allocated to manufacturing ends up being applied to the labor to make his product and hence ends up in COGS (Cost of Goods Sold). If we take a very simplistic view of this we could say that every hour in labor has a burden of $1.00 in overhead for the cost of the 5,000 sq. ft. of manufacturing space. If the owner changes the rules and says that he will put the total cost of his facility as an overhead to manufacturing then for every hour of labor the burden is now $2.00.
This only becomes a problem for the potential buyer if sales are down and manufacturing is still producing at the same rate, in other words manufacturing is still producing the same amount of items. If sales are in fact growing then this adjustment has little if any value to the seller.
Prior to making the change in overhead his financial statements would appear like this:
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After making the change in overhead his financial statements would appear like this:
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In the aforementioned example the owner of the business that you are considering buying, has managed to increase his profits by $25,000 just by maneuvering his overhead allocations. I want to point out that in this scenario there is absolutely nothing illegal (immoral definitely) in what the owner of the business has done.
One of my favorite set-ups occurs when a business owns its facilities (buildings). The manipulation is created when the owner of both the building and the business severs the building from the current business and places the building into a completely separate corporation. He then as the owner of the business pays himself a very low monthly rent with no written lease. Reducing the rent that the business is paying for occupying its facilities has the effect of increasing profits for the business. Although the corporation that owns the building may actually be loosing money, as he owns both entities, the business and the building it has no real financial effect on him. He is basically just moving money from one of his pockets to the other. However, as he is trying to sell the business, not the building, he has managed to inflate the profits of the business through this manipulation of rent expenses. If you do actually acquire the business he will then, as your landlord, present you with a dramatic rent increase that eats heavily into your profits.