Accountants Guide to Buying a Small Business
This Accountants guide discusses buying a business and buy business tips. Sometimes the best way to become the owner of a business is to buy a going concern. If you are considering this option, most of the factors already discussed should be considered plus these additional points.
Accountants Tip: Advantages to Buy Business
Accountants list certain advantages may be gained by buying a going business.
- You may be able to buy business at a bargain price, if, for example, a owner is sufficiently eager to sell.
- Buying a business as it stands will save time and effort in equipping and stocking it.
- You gain customers accustomed to trading with the establishment.
- Key personnel with customer or client following may be willing to stay.
- The “good will’ founded by the prier owner may be a valued asset. You may end up spending more than you wanted on your business because of your inaccurate appraisal or the previous owner’s misrepresentation. Accountants recommend hiring a reputable business appraisal company.
Accountants Tip: Disadvantages of Purchasing a Business
- If the owner has a bad reputation you would end up keeping the reputation of former customers and, perhaps, of merchandise and equipment suppliers.
- Not a Solid Location.
- Check all equipment for any damages or wear and tear. (Check carefully.)
- Too much of the merchandise or materials on hand may be old or poorly selected. When deciding how you should be paying for a going small business, consider the potential for profit. Tangible assets such as equipment and inventory could be value assets, but only to the extent that they will yield a profit in the future. If the seller is asking for a large amount for the intangible asset of good will, be careful when estimating how much – if anything – it will add tow future profits. Last but not least, determine and assess the cost of any liabilities you will be expected to assume. Be sure to have it in writing!
Accountants Tip: Profit Potential
- In order to accurately estimate future profits, you and your accountants should start by analyzing the current owner’s balance sheets and profit and loss statements for 5 years going back. Going back 10 years would be even better. Most businesses have insufficient or no records, but they should all have copies of their income tax returns. At times even these are slacking or, more likely, suspicious. Certain businesses have been known to “cook the books” and cerate inaccurate tax return. Insist on seeing accurate records. If you decide that you are sure about purchasing a particular business, think about making a deposit subject to getting accurate business records.Do not be discouraged from buying the business if the past profit records are not looking to good. Accountants often say the reason the business is for sale is because of recent lack of income. Upon further inspection, it was revealed that lack of income was due to poor management. By the same token, an excellent past earnings’ record, in itself, should not persuade you to pay a large amount for the business without further investigation.If you are not familiar with accounting and income tax records so that you may verify records of past operations and make a reasonable forecast of future operations, have an experienced accountant or management consultant work with you to help you understand the records and assist you in your evaluation.
Accountants Tip: Tangible Assets
- What is the condition of the inventory you are purchasing? Is the stock current, clean, well-balanced, in good condition? How much of it will have to be disposed of at a loss or given away? Make a careful appraisal of the stock. Each item should be separately priced and given a reasonable value. If at all possible, the inventory should be “aged”; that is, the length of time each group of items has been in stock over 18 months old, 1 year to 18 months, 6 months to 1 year, and less than 6 months should be calculated. Usually, the older the inventory, the less its value.Make certain how much of the asking price is for furniture, fixtures and equipment. The business may not warrant the investment which the owner made. And, finally, find out if there is a mortgage on any of the fixtures or equipment, or if they even have been completely paid for.
Accountants Tip: Goodwill in Buying a Business
- Because you are paying for favorable public attitude, make the effort to check it. Question customers, bankers and others whom you feel have unbiased opinions. Who will have the goodwill after the business changes hands? Does it go with the business, or is it personally attached to and will it remain with the seller?Or compare the price asked for goodwill with that asked for goodwill in similar businesses. In other words, if you are shopping around for a business, compare not only the total prices asked, but the amounts asked over and above the reasonable value of the net tangible assets.
- The term “goodwill” is an accountant’s fiction designed to explain the difference between the real price and the net worth. Accountants usually prefer writing off this “goodwill” in short period of time. Another way to judge the value of this intangible asset is to estimate how much more income you will receive by buying the going business than by starting a new one.
- Do not mistake it with “net worth”, which is the difference of the dollar values of the assets and liabilities of the business. Instead, it is the capability of the business to recognize a higher rate of return on the investment than regular in the certain type of business because of the favorable public attitude started by the owner. When goodwill leaves, it is a valuable asset.
- If you are taking over the assets such as accounts receivable, credit records, sales records, mailing lists, or leases, investigate them closely. Accounts receivable should be aged to determine how many of them may be so old collection will be difficult or impossible. On the other hand, records and contracts involving favorable leases have real value. Make certain these are included in the sale.
- Examine equipment and fixtures carefully. Remember you are buying second-hand furnishings with only a percentage of their original value. Be sure equipment is in working order. Find out its age. Obtain evaluations of similar equipment, new or second hand, from dealers. Not only should you know how much equipment and fixtures have depreciated, but how obsolete they may be. Office equipment may be in working order, but so obsolete that to use it would be inefficient and costly. Also, it may be difficult to obtain repair parts for old equipment in case of a breakdown. Store fixtures quickly become out of date. New, modern fixtures attract customers. Machines used in factories may have been superseded by far more efficient equipment. To pay an exorbitant price for old machinery, no matter how good its condition, is most unwise.
- The most commonly purchased tangible assets, in the buying business process, are merchandise inventory, equipment and fixtures, and supplies. If the business you plan to purchase sells on credit you probably will take over accounts receivable.
- Ask the seller to prepare a projected statement of profit and loss for the next 12 months. Such an estimate will probably be very optimistic and should be compared with your own estimate. With a detailed estimate of the next 12 months’ operation, you can compute working-capital requirements for each month. Next, estimate the value of assets and liabilities as of the end of that period. Find the estimated return on investment by dividing the projected net profit by the price asked for the business. If you believe additional investment will be needed immediately to make the business run profitably, add this to the price in your computations. The highest price for the firm which brings you a return with which you are satisfied is the maximum price you should pay for the business. Thus, an estimate of future profitability will give you the basis of a logical offer for the business.
- Study the expense ratios. How does the percentage for each expense classification compare with the average for the trade? The availability of average operating ratios for certain trades has already been mentioned. Comparison of the figures of the business offered for sale with standard ratios will bring out any discrepancies. In discussing these discrepancies with the seller you may become aware of operating problems which will help in making up your mind how much to pay for the business, or whether to buy it at all.
- When deciding if business is worth buying, you and your accountants must be aware of future profitability of the business. Almost all businesses have what you would call a “natural cycle”. Retail stores usually have a cycle of once a year. Each year follows the same pattern and several years indicate a trend. Specific types of heavy manufacturing companies could have up to a seven-year cycle. Try and guess multiple (typically, at least three) cycles. In certain businesses you are estimating three to five years however in another business you may need to be estimating future sales and profits over a 25-year period. Obviously your estimate for the next two years will be more precise than your estimate for 25 years in the future. This does not mean you shouldn’t care in your long term planning. However, It does mean your long range estimates will be more general and subject to change.