This article are provided for information purposes only, and are not intended as legal advice.


Buying a business – what do you look for when looking at financial statements?

February 9th, 2009

You find a business that appeals to you and now you need to do some preliminary review of the financial statements to see if you want to continue to the next step.  The first thing that you should do is some high level analytical review.  Analytical review is looking at trends on the financial statements to see if there are glaring relationships which do not make sense.  For example if sales increased by 5% but cost of goods dropped by 5%, this is not consistent.  You need to ask what happened.  Did they switch suppliers to get a lower cost or did they forget to relieve inventory and inventory on the balance sheet is overstated. 

 

Did bank debt decline but payables to suppliers increase?  This could indicate some change to the banking line.  Are suppliers giving them greater credit lines or is the company very extended and in financial difficulty.  If sales dropped and accounts receivable increased, this trend raises questions.  Are the receivables collectible, are some customers in financial difficulty, do you need to set up a bad debt provision which will drop the profit of the company and have an impact on the value of the company?

 

What if the salary expense dropped but revenue increased?  Does this make sense, does it appear that all salary expenses are recorded?  Did the owner and his family drop the amount that they were paid in order to improve the profitability of the company? 

 

There may be an explanation for everything but you want to make sure you understand the business.  If you are not analytically minded, you may want to hire an accountant to do a very quick review as i have done above to see if the financial statements make sense.  If you are unhappy by the vendors answers, you may want to stop pursuing this business and look for another business for sale.  if your questions are answered and you are happy with the answers, then you should continue pursuing this acquisition.


Filed under: Buy a business,Due diligence — Gary Landa @ 10:09 am


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