Buying a Business: How to Assess Its Financial Health
Starting a business can be a massive undertaking. It requires a great deal of time, planning, and capital, and countless considerations come into play. All those factors must come together in just the right way to get the business up and running and keep it on its feet. For many aspiring entrepreneurs, buying a preexisting business in the niche they want to pursue is a better alternative. It eliminates much of the guesswork involved in starting from scratch and allows them to start operating much more quickly.
That being said, it’s important to consider several factors when buying an established business too. Those include the business’s customer base, market presence, intellectual assets, and previous levels of success. Of course, its financial health is crucial aspect to think about as well. You’ll need to understand that factor to determine its potential for future growth and which risks might be involved for you as its new owner. It’s also essential for securing financing for buying a business. Using the following strategies can help you to determine a business’s financial health before making a commitment.
Assessing the Cash Flow Statement
One measure you can take to determine a business’s financial health is assessing its cash flow statement. This is basically a record of the money coming into and going out of a business. It’s divided into three basic categories.
One category is the business’s operational activities. It shows the business’s income from sales and other sources. It also shows expenses, like employees’ salaries, payments to suppliers, and other typical outlays. A cash flow statement that shows positive operating income is a good indication of a financially healthy business.
Another category is financing activities, and it details cash flow that’s related to funding the business. It covers factors like loans, issuing dividends to shareholders, and selling or buying back stock. Investing activities is the third category here. It covers the money used for long-term investments or generated from selling assets. It may include equipment purchases, acquiring new land or facilities, and other investments in the company itself. High investing outflows may indicate that a company is growing and evolving.
Looking at the Profit and Loss Statement
Another step in determining a business’s financial health is looking at its profit and loss statement. This document shows you a business’s income and expenses during a specific timeframe. It shows the business’s revenues from sales and other sources, the costs of producing products or providing services, and its remaining profits after covering those costs. It also shows you the business’s operating expenses versus the profits they produce and its taxes, interest paid on debts, and additional expenses in comparison to its actual net profits or losses.
Examining Tax Returns
Looking at a business’s past tax returns can also give you insight into its financial health. Tax returns from the last three to five years can tell you about the business’s income trends and fluctuations, potential deductions, payroll, interest payments, and many other important points. They can give you an idea of how steady the company’s revenue is, whether its assets are depreciating, how stable its workforce is, and several other key considerations.
Determining a Business’s Financial Health
Understanding a business’s financial health before buying it is crucial. It can help you determine whether the business would be likely to succeed and make money or it would cost you more than it’s worth. These measures listed here can aid in determining a business’s financial health and stability so you can make a more informed decision about whether it’s the right investment for you. They can also help you find businesses that you’ll be able to get financing for so you can get started on your entrepreneurial journey.
