Are you ready for a crash course?
If you’re in the market to buy a business, a major part of your acquisition will be carefully reviewing the finest financial details of your target company.
Profit and loss (P&L) statements (1), cash flow statements (2), and balance sheets (3) are all critical documents you’ll want to review when vetting a company up for sale.
Each tells an important financial story and provides vital stats on a business’s health, giving you a sense of its true value and longevity.
If you’re in the market to buy a business, a major part of your acquisition will be carefully reviewing the finest financial details of your target company. Profit and loss (P&L) statements, cash flow statements, and balance sheets are all critical documents you’ll want to review when vetting a company up for sale.
Each tells an important financial story and provides vital stats on a business’s health, giving you a sense of its true value and longevity.
These three documents are a core piece of your due diligence. See our the first part of this series of articles for details.
Still, you’ll also want more information about their tax filings and earnings before interest, taxes, depreciation, and amortization (EBITDA). Here's an explanation of various financial documents.
Tax Returns
Tax returns summarize the business's taxable income, deductions, and tax liabilities, offering insight into the company's profitability and financial stability. By examining a business's tax returns, a buyer can evaluate its cash flow, identify potential tax issues or liabilities, and determine the level of risk associated with acquiring the company.
The information in tax returns can also help buyers negotiate the purchase price and understand the tax consequences of acquiring the business.
Accounts Receivable and Accounts Payable Reports
Accounts receivable and accounts payable reports provide a snapshot of a company's outstanding invoices and bills owed to suppliers. Accounts receivable reports show the amounts that customers owe to the business for goods or services that have been delivered but not yet paid for, while accounts payable reports show the amounts that the business owes to suppliers for goods or services that have been received but not yet paid for.
These reports help businesses keep track of their cash flow, manage their financial obligations, and ensure that they collect payments and pay their bills on time. By analyzing these reports, businesses can identify areas where they need to improve their cash management practices and take appropriate actions to address any issues.
Inventory Reports
Inventory reports show the levels and the valuation of a company’s goods. These reports are essential for businesses to manage their inventory efficiently, optimize their stock levels, and avoid stock-outs or overstocking.
By analyzing inventory reports, businesses can identify trends in their inventory levels and adjust their purchasing and stocking practices accordingly. For example, they may notice that certain items are selling quickly and modify their orders to ensure they don't run out of stock.
What to Look for in Financial Documents
The documents you get are only as useful as your ability to review them for the right information. This means piecing together details across different records to understand better how well the business is doing. See the third part of this article for more details.
Ask Questions and Seek Expert Advice
It’s important to ask questions and seek expert advice when reviewing small business financials. Ask the seller for clarification on any issues or discrepancies that you identify. You may also want to ask for advice from a business broker, accountant, or another financial professional who can provide additional insights and guidance.
Reviewing small business financials is an essential step in the process of purchasing a business. By obtaining and analyzing the necessary financial documents, calculating key financial ratios, and looking for red flags, prospective buyers can fully understand the business's financial health and decide whether to proceed with the purchase. Remember to seek expert advice and ask questions to ensure a thorough review of the financials.
This article is reposted, with permission, from DealStream.
May 1, 2023