One of the most important steps you will take towards buying a business will be to make a sound judgement on the viability and true worth of what you are buying.
In a sense, you must play the part of a good detective and uncover the truth about the business you are buying.
The first assessment you must make in evaluating a business for sale is to review its history and the way it operates.
It is important to learn how the business was started, how its mission may have changed since its inception and what past events have occurred to shape its current form.
You should also understand the business's methods of acquiring and serving its customers and how the functions of sales, marketing, finance and operations interrelate.
The business's financial statements, operating documents, and practices should also be reviewed thoroughly.
EVALUATION
The following are the main sources you should use to evaluate a business for sale:
Balance sheet
Ask to take a look at the balance sheet of the business. This should give you records for accounts receivable, inventory, marketable securities, real estate, machinery and equipment, accounts payable, accrued liabilities, notes payable and mortgages payable.
Income statement
Check the income statement. The potential earning power of the business should be analysed by reviewing profit and loss statements for the past three to five years. The business's earning power is a function of more than bottom-line profits or losses. The owner's salary and fringe benefits, non-cash expenses, and non-recurring expenses should also be calculated.
Financial ratios
Check the financial ratios. While analysing the balance sheet and the income statement, sales and operating ratios should be calculated in order to point out areas requiring further study. Key ratios are the current ratio, quick ratio, accounts receivable turnover, inventory turnover and sales/accounts receivable. Look for trends in the ratios over the past three to five years.
Odds and ends
Find out the situation with the business's leases, personnel, marketing, patents, taxes, legal issues and competitors.
Outside help
These factors for evaluating a business have to be carefully scrutinised and weighed. Seek out professional assistance if needed to interpret the significance of the information. In most instances, all of the business records should be made available to you. In some cases, however, certain information may be withheld until a bona fide offer, contingent upon obtaining that information, has been made.
VALUATION
Once you have evaluated the business, you can determine its value and a price you think is reasonable to pay. Many factors can determine value and valuation has often been described as more of an art than a science.
Check the following factors:
recent profit history;
general condition of the company (such as condition of facilities, completeness and accuracy of books and records, morale and so on;
market demand for the particular type of business;
economic conditions (especially cost and availability of capital and any economic factors that directly affect the business);
ability to transfer goodwill or other intangible values to a new owner; and
future profit potential.
Other factors often come into play in arriving at an agreed upon price, perhaps due to special circumstances of the particular buyer and seller.
These are trade-offs between cash and terms, and relative tax consequences for the buyer and seller, which depend on how the transaction is structured.
Rule-of-thumb formulas provide a quick means of establishing whether a price for a certain business is 'in the ballpark'.
Formulas exist for many businesses. They are normally calculated as a percentage of either sales or asset values, or a combination of both. You can use one of these methods:
- Comparable sales
- Balance sheet methods of valuation
- Income statement methods of valuation
