If you’re considering buying a business, read these bookkeeping tips to learn how to evaluate the financial health of a business before you buy.
Whether you are an entrepreneur looking for a potentially lucrative investment, are a pragmatist seeking a recession-proof source of income or have decided the current environment could offer the chance to get a good business at a low price, here’s how to approach the process.
Ask the Right Questions
The first question to ask before buying an existing business is: Why is it for sale? This is not to suggest that any business available for purchase is inherently a risky investment. There are perfectly legitimate reasons for a business owner to sell out, from retirement, to health issues, to short-term financial stresses like the novel coronavirus outbreak.
But there are also times when a “For Sale” sign is a red flag. In order to determine which category a prospective business investment falls into, you need to probe further.
You’ll want to know:
- Is there a history of financial difficulties?
No one should ever buy a business without conducting due diligence. Any business owner who is serious about selling will agree to provide three to five years’ worth of detailed financial records compiled in accordance with generally accepted accounting principles (GAAP). If a business owner can’t provide clean records or is evasive when asked for such information, walk away immediately.
- Has the business continued to grow?
Establishing that a business hasn’t been hemorrhaging cash is a good first step. But you should also find out whether the business has continued to generate cash. If the revenues have plateaued in recent years, that’s not necessarily an indication you should walk away. You might be able to grow the business by eliminating inefficiencies and exploring new markets. But you should make that determination before you buy.
- Can you make the business profitable?
Using the same financial records you examined when evaluating the business, you can work with a bookkeeping and controller services provider to create comparative profit-and-loss and cash-flow statements, which form the basis for one- to five-year projections. Any financial institution you approach for funding will require this information.
- Can you find financing?
The usual avenues for funding for business acquisitions may not be readily available through traditional lenders. Many times alternative financing is available through commercial loan brokers with very competitive rates.
It Takes a Network
Depending on the type of business you want to buy, you may need a network of professionals who can assist you during the process. A good bookkeeping and controller services provider will have relationships with many of the professionals you might need. These include:
- Business attorneys: Never buy a business on a handshake. Be sure to engage a good business attorney to draw up or review a contract.
- CPAs: A good CPA will be able to advise you on the best legal structure for your business and give tax-planning advice.
- Payroll providers: If the business you’re thinking of buying has a significant payroll, this is one area where you’ll want professional advice on what to look for in a payroll provider.
- Insurance and benefits agents: There are many types of specialty insurance you should explore. If your business will have a small staff, for example, you might want to look into key-person insurance. A larger business might require a wide range of benefits to encourage good employees to stay.
- Franchise attorneys: Franchises are a unique form of business. A franchise attorney can provide advice specific to this type of business.
You Don’t Have to Go It Alone
This might turn out to be the right time to buy the business you’ve always wanted. But it’s also a time of great uncertainty. It’s reassuring to know that as you try to get a business of your own, you can rely on your bookkeeping and controller services provider to help you every step of the way.
Excellently written by Peter Holmes