How to Evaluate Financial Statements When Purchasing a Business
Investing your time and resources in the acquisition of an existing business should not be taken carelessly. Prospective business owners are required by investment best practices to seek for companies for sale with healthy balance sheets, good earnings, and positive cash flows. Knowing what to look for in financial statements will assist you in determining whether the business you’re considering purchasing is a good investment.
Three Essential Financial Performance Reports You Must Examine
Before analyzing the financial status of the firm you wish to acquire, it is essential to understand about the company, the products or services it sells, and the industry it operates in. However, when you’re ready to examine a company’s finances, you should review the three sets of financial information that are typically used to evaluate business value: the income statement, the balance sheet, and the cash flow statement. We suggest reviewing these financial accounts with a reputable accountant or business broker who can translate and clarify the financial jargon.
1. Income Statement
The income statement, often known as a profit and loss statement, is an essential yearly report that public corporations are required by law to present to the Securities and Exchange Commission (SEC). Companies that are not publicly traded on the stock market are not required to file their income report to the SEC, but as a buyer, you should still request to understand their finances. In this study, revenue, expenses, profits, and losses are four crucial aspects that help us determine a company’s bottom line.
A straightforward method for calculating the bottom line (net income) is to deduct a company’s operating expenses, such as the cost of goods sold, gross profits, depreciation charges, and income taxes, from its top line (gross revenue), which includes future cash inflows like as credit sales. You are not required to instantly abandon a firm that is not yet profitable. If it indicates a clear route to profitability, you may be in the clear, but you should still see your business broker or counselor first.
It is vital to remember that the income statement can also provide insight into the company’s operations, management, underperforming sectors, and competitive position.
2. Financial Sheet a prospective buyer examining a company’s balance sheet
The balance sheet provides a snapshot of a company’s financial health at any given time. It describes the company’s assets (current assets), its liabilities (liabilities), and the difference between the two (shareholders’ equity). Denoted by the term “balance sheet,” the company’s assets should always equal its liabilities plus its shareholders’ equity. In other words, the company’s current assets should exceed its current liabilities. If there is a gap, compare the balance sheet for this period to prior reports to identify any trends.
This document also provides information about a company’s liquidity ratio. Their current ratio indicates if the owner has sufficient cash on hand to cover short-term liabilities and cash flows without raising more capital.
You should also review the company’s accounts receivable, as some customers or clients may owe the company money. If this is the case, establish if the present owner will balance the accounts before you purchase the business, or whether you will be responsible for collecting those payments.
3. Income Statement
A cash flow statement details the movement of cash and cash equivalents into and out of a business. As a general rule, a corporation should create sufficient cash to cover expenses and purchase assets. Analyzing a company’s cash flow allows us to determine where its funds originate and how they are spent. Cash from operating, investing, and financing operations should be detailed on the cash flow statement. You can even use reports from current and prior years to anticipate future cash flow. Note that a profitable business might nevertheless have cash flow concerns.
We usually recommend reviewing the income statement, balance sheet, and cash flow statement side-by-side and noting any inconsistencies. But assessing a company’s financial health requires significant effort, and you may not always comprehend what you’re seeing. Regardless of where you are on the buyer’s journey, a business broker is a worthwhile investment. Let us help! For our Sunbelt Business Brokers office will be a pleasure offer the assistance you need to complete a successful transaction.
Our best advice? Don’t waste another day and talk to a Sunbelt South Florida broker today!
Sunbelt Business Brokers of West Palm Beach provides dedicated business brokerage services for all of your selling needs. Whether you are an established business owner nearing retirement and looking to sell, or an ambitious entrepreneur seeking your next investment opportunity, there is no reason to look beyond Sunbelt Business Brokers. Visit us at 800 Village Square Crossing
Suite 216 Palm Beach Gardens, FL 33410 or contact us at (561) 832-9222.