10 Steps in Buying a Business – Part 2

Last time we started looking at factors to consider when buying a business. Here is another very important step focused on the financial aspects.

4. Track Record. 5 years of tax returns and their attachments will tend to tell the worst-case story as the owner will have attempted to minimize their tax by minimizing their stated earning. Tax returns tend to provide you with a test for any written back charges that the seller or their accountant may have entered into the P&L and Balance Sheet provided to substantiate their asking price.

a. Attachments will include the Aged Receivables, Inventory and Assets, and will show you the book value of these assets. Those will generally be less than the client is asking since they’ll have written down as heavily as they can to maximize tax advantages.

b. Plant and Equipment and Depreciation Schedules can tell a story. If there is a steady history of updating equipment – leases, rolling over equipment, replacement items, then you know you are unlikely to be taking on too many equipment “time bombs”. Conversely, if the picture these documents paint is one of little equipment upgrading (check the P&L expense items for equipment maintenance) you may find that you are buying into a business that has a massive need for fresh capital investment very shortly after you take over.

c. Reading between the lines of the Aged Receivables will tell you a fair bit about how well this business has been run from a credit and cash flow control perspective for the last few years. This area alone can reveal stress and reasons for your seller to sell. Remember, if their Receivables Ledger shows a bunch of free loading clients, you are about to inherit those, and changing their behavior and habits is likely to be hard, and to result in loss of business as they go elsewhere looking for easy credit. Looking at Current Customers over time will also give you some insights into the average lifetime of a key customer, their lifetime value, profitability, etc. All vital information for the future if you buy, as these will be the lifeblood of the business.

d. Customer Contracts. Assess whether the business has any forward commitments from its customers in the form of 1, 2 or 3 year service or purchase contracts. Assess how sound these are, and how profitable they are. They may be great for bulking up sales numbers, but do they yield profit? You will be asked to pay a factor of their forward value; you had better make sure that value is there.

e. 5 years of Aged Supplier Lists will tell you lots about cash flow within the business and about the relationships you can expect from the suppliers you inherit with the business. Ask for any evidence of recent changes in credit policy by major suppliers as these alone could be the trigger for cash distress and sale, indicating an underlying issue of profitability or management in the business.

f. Supplier/Distribution Contracts. Check to see what on-going and transferable contracts may give you an immediate and on-going advantage in your new business. What is the term of these? How long do they have to run? How advantageous are they? What obligations go with them?

Next time, we will look at the remaining 6 steps.

Combining Vision and Innovation to Create the Future

Start here to gain that competitive edge: http://www.ignition-pathway2growth.com/

© Rich Kohler 2015. All rights reserved. For copies, please contact Rich at rich@rich-kohler.com.

Tags: , ,

Leave a Comment