Although I am a very optimistic person, I am still not at all convinced we are close to making a turn towards a better economy yet, and this is clearly the case in the business for sale marketplace. The tidbits of positive news that seep out to me are still sugar-coating the reality.

Nevertheless, I remain steadfast in my belief that it is an incredibly opportunistic time to buy a business, and specifically because of the deal terms a serious and savvy business buyer can negotiate.

While investigating any business today, there are numerous key issues to consider, and a buyer’s investigation must go deeper than usual.

Today I want to talk about two areas that you need to lookout for when buying a business today:

Financial Statements

As you investigate a business, at the appropriate time you will have access to the company’s year-end financial statements and tax returns. In “normal” times, these periods could provide you with a reasonably accurate view of the recent trends, barring any catastrophic events. Of course, interim statements between the last financial year and the time when you are reviewing the company can also be helpful.

In today’s economy however, you must dig way beyond what a seller will normally provide. In addition to having complete year-end and interim statements, you absolutely need to get trailing 12-month statements. This is a financial statement that captures the activity for the last twelve months from today through to the current month. In addition, you will want to see statements from the prior 12 months and the same period before that.

So, for example, if you are looking at a business today, you will need to see the company Profit & Loss statements covering:

– October 1, 2008 to September 30, 2009

– October 1, 2007 to September 30, 2008

– October 1, 2006 to September 30, 2007

Now, you may be asking yourself what you can really diagnose, since these trailing twelve-month and calendar reports each cover a similar time frame. Actually, there is a huge difference.In today’s economy, the most critical aspect of any business you review must be the most recent trends. Since many businesses are experiencing declines, if you look at financials from more than a couple months ago, there can be a whole different story since then.

Furthermore, many sellers will do what they must to make their last calendar reporting period look better if they are attempting to sell a business. By reviewing the trailing twelve-month reports, there is no escaping what is really going on. Plus, you need to compare it to like periods earlier to see how those periods ended up and can determine how the business is truly performing today versus prior periods.

Similarly, you will want to measure other key ratios versus the same period in prior years. For example, what is the backlog of orders by month in the past three months versus the same three months one, two and three years ago? Or, what are inventory levels, number of transactions, average sale amount, and any other meaningful and measurable factor.

Again, the idea is to get a very good handle on how the business is trending right now, since the only viable data upon which you can determine what the immediate future holds for any business is to measure what has happened in the most recent past.

Expense Cuts

There are only two ways to increase profits: generate more sales or cut expenses.

Many years ago, a gentleman named Stu McClellan, was brought in as a consultant to a company where I was working. Our business was in severe decline. When the company executives outlined all the expense cuts being made, he said: “You can save your way to solvency, but you market your way to success.”

Those words are especially true today. When a business is not growing, and the owner wants to sell, they have only one way to make the numbers look better and that is by cutting their expenses to show a better profit picture. Don’t be fooled!

Look at every non-fixed expense, including marketing, payroll, and advertising. Use a period-to-period, item-by-item comparison of what they were in prior periods versus the current one. Note the percentage they represent related to sales and look for anything out of the ordinary.

Also, review the Balance Sheet to see if they are taking longer to pay their bills, cutting inventory or perhaps it is increasing, or if there are any new shareholder loans on the books to see if the owner may have injected some of their personal money into the business recently.

Summary

Regardless of the economy, the investigation of any business for sale must be thorough, but in these times, you have to be especially diligent.

There are some businesses that truly are suffering simply as an extension of the macro economy and will rebound as the economy improves.

However, there are others that won’t make it. As such, you cannot simply broad-brush a declining business’ status to an arbitrary event. You need to learn exactly why the business is in its present state, and whether or not there is a quantifiable reason for it. Most importantly, are the fundamentals in place to indicate things are improving, or at least have leveled off, and can be sustained from this moment on, and grown in the future.

There are numerous other factors of course to consider when buying a business today.

If you haven’t already done so, pick up a copy of our report Buying a Business In A Tough Economy.

Have a great week.