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Finances and sales due diligence when buying a business
When you're considering buying a business, due diligence involves a detailed review of the business's sales performance and financial data. It is a good idea to consult a professional adviser to help answer the following questions.
- Have you analysed the financial records for the past 3 years, including balance sheets, profit and loss statements, tax returns, purchases and sales records and bank statements? Have the records been well kept? Do they show potential for growth? What do the profitability and liquidity ratios show?
- Based on past financial results, have you projected the future cash flow and profitability of the business? What is the break-even point?
- Are you buying the accounts receivable? Do you have an aged listing of accounts receivable? Have you made adequate provision for doubtful debts?
- Has the previous owner received any payments in advance (e.g. deposits) that they should turn over to you?
- Will you have to build up your own accounts receivable? Have you worked out how this will affect your cash flow?
- Could you sell the accounts receivable to a factoring agency (bank or finance company) in order to generate cash flow into the business? What would be the implications of such a move?
Sales patterns and records
- Are sales records reliable? Are the total sales broken down by product line?
- Are bad debts deducted from sales, or are they still shown as receivables? Is the percentage of bad debts within industry standards?
- What are the sales patterns year-by-year and month-by-month? Is the pattern seasonal or related to some business cycle (e.g. home construction or other uncontrollable variable)?
- Are there fluctuations in sales due to one-off sales?
- Are you sure all sales figures shown are for this business, and that the seller hasn't added sales from another business?
General sales information
- Is the product or service likely to maintain or improve its marketability or is it in danger of becoming over-sold, out of style or obsolete?
- Can you increase sales with current resources?
- What is the sales mix (the ratio of each product sold to total sales)?
- Can you achieve the required sales targets?
- Do you know the minimum and maximum likely sales?
- Is a particular salesperson critical to success? If so, will you be able to retain that person in your employment?
- Do a small percentage of clients represent a large percentage of sales?
- Is the seller continuing on with another business that may have some effect on the future sales of this business?
- What is unique about the business's product or service?
- Are you satisfied that the expenses disclosed include all expenses incurred by the business?
- Has the seller covered the business with the necessary insurance cover?
- Have all compliance requirements (Work Health and Safety, Quality Assurance and Environmental compliance) been met and do they appear in the accounts?
- Beware of the add backs, which usually include personal expenses that had been charged to the business and have been credited back for the purposes of valuing the business.
- Have you looked at the effect of increased or decreased sales on profit?
- Have you considered the effect of inflation on sales and costs in the years to come?
- Are profits adequate to warrant the risk of buying?
Warranties and refunds
- Are any goods on warranty? If so, should you make a financial allowance for possible warranty commitments?
- Will clients expect you to make refunds or warranties even in instances when you're not legally obliged to do so?