INITIAL INVESTMENT ASSESMENT

- Latest annual financial statements (AFS)

- Revenue
- EBITDA
- Depreciation
- Amortization
- Capital Expenditures
- Working Capital
- Cash and Cash Equivalents
- Debt
- Discount Rate (weighted average cost
of capital – WACC)
- Short term revenue growth rate (if
company is still growing)
- Long term revenue growth rate (at
maturity)
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Home
> Starting a business
> Tools and Checklists
> Checklist: Evaluating the purchase of a business
Checklist: Evaluating the purchase of a business
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Last updated on December 18, 2012
A successful evaluation should indicate the potential of the business and enable sales, profit
and cash flow projections to be made for at least the next 12 months.
It may be tempting to act quickly so that you don’t miss out on what you think is a good
opportunity.
It’s worth taking the time and putting in the effort to ensure you make the right decision.
Seek the advice of professional advisers who will help you as you evaluate the following
aspects of the business under consideration:
1Reasons for selling
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Find out as early as possible why the current owner has the business on the market and how
highly motivated they are to sell - this will help you establish how much scope you have to
negotiate price and terms.
Obtain good information by asking a series of well-structured questions - if you feel you’re
not getting straight answers, try asking the questions in another way.
2Profit
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Look at the performance of the business over time and determine why the business is
making a profit or loss - exercise caution if a good profit is only a recent occurrence.
Consider the trends apparent in the gross profit margin and compare this with the industry
norm - a decline may indicate anything from incorrect stock figures to heavily discounted
prices to a high level of pilfering.
Calculate the net profit margin on sales and identify the reasons for any trend in net profit -
it may be that sales are lower or expenses higher.
Assess whether profits are enough to take the risk - remember that a business can only be
truly assessed on figures that can be verified, so ignore ‘black money’ or undeclared income
which the vendor may claim is regularly taken out of the business.
3Sales
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Obtain a detailed breakdown of sales and assess:
the sales trend
whether the product or service is likely to maintain or improve its marketability or if it’s in
danger of becoming over-sold or obsolete
where sales are in relation to inflation
what is selling and what is not selling
the conversion rate of inquiry to sales orders
who is buying the product or service.
Verify figures by:
inspecting invoices and statements from suppliers
inspecting daily cash books, bank statements and income tax assessments
asking employees how many customers they service daily and details about the average sale
asking neighbouring businesses how busy the operation is
surveying numbers of customers patronising the business over a period of time.
Consider the stock of the business and determine:
the trend in stock levels relative to sales
the amount of stock normally carried in relation to turnover of the business
the number of stock turns achieved in a year
whether stock figures are accurate and not inflated – old slow-selling stock for which
invoices are ‘hard to find’ can often be included in the stock figure at inflated prices
whether goods have been supplied with warranty – if so, you’ll need to make allowance for
possible warranty commitments.
4Expenses
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Investigate all aspects of expenditure, including whether:
there is a trend in expenses
private expenses of the vendor have been shown as business expenses – the areas of most
frequent abuse are telephone, wages, motor vehicle, advertising and insurance
advertising costs are in proportion to business turnover
there is a balance of expenditure on light and power relative to sales
repairs and maintenance contain any one-off expenditures – a high level of repairs and
maintenance could mean the business has a large amount of old or unreliable equipment
salary drawn by the vendor has been included in wages
drawings by the vendor have been variable or irregular
there are any additional expenses that would have to be incurred under your ownership
the vendor has received any unpaid assistance while operating the business – if so, you’ll
need to make allowance for this in your financial projections.
5Assets of the business
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Stock
Organise an independent stock count with attention to:
age
quality
saleability
style
condition
balance
suitability
freshness.
Establish whether any goods are on consignment, with the right of being returned for full
credit.
Building, furniture, fixtures and equipment
Wherever necessary and appropriate, arrange independent appraisal, assessment and
verification as you determine:
the market value of the building, furniture, fixtures and equipment
how useful, modern, efficient and usable they are
whether all local council and health regulations are satisfied
how much the vendor has spent on keeping the facilities in good condition
whether there is any money owing under hire purchase or lease agreements
if any assets are located elsewhere and, if so, whether they are subject to a lien
whether the depreciation policy has been realistic.
Accounts receivable/debtors
You have no obligation to take over outstanding debtors – if you decide to do so, ensure
that customer lists, business and credit records and mailing lists are included in the contract
of sale.
Make an assessment of your prospects for collecting on outstanding accounts based on the
quality of debtors and the prevailing economic climate.
Assess the success of the vendor in past collections – determine the average collection
period from financial statements.
Check the volume of business coming from credit customers with slow payment records and
consider the implications for working capital.
Supplier and credit relations
Assess whether supply sources are satisfactory and whether they are likely to continue on
favourable terms – if not, check whether the business is committed to them by contracts.
If future deliveries are scheduled, determine whether they should be increased or cancelled.
Assess how the business would be affected if key personnel were lost.
Consider whether existing employees will be an asset or liability to you as the new owner.
If you are considering any changes, be alert to potential liabilities for redundancy payouts.
Assess the reputation of the business and whether it has an established, satisfied clientele –
you’ll need to allow for a probable loss of a certain percentage of clients when preparing
budgetary projections.
Determine whether any contracts that are in place with key customers are transferable to
you.
Establish whether the contract of sale prevents the vendor from re-entering business in
competition with you – have the contract checked by your legal adviser.
Trademarks, patents, copyrights and other intellectual property
Determine whether they are included in the contract, whether they are transferable, and
whether they will be as valuable in the future – seek the help of your professional advisers
as required.
Franchises
Contact the franchisor to find out whether an exclusive franchise is transferable to you and
any transfer requirements.
Assess the terms of the franchise, how long it has to run and its value to you.
Lease
Seek the advice of your professional advisers before signing any lease and make sure that:
it is transferable to you
the terms enable you to undertake the activities needed to operate your business
it is included in the contract of sale so that the legal obligation to purchase depends on
availability of the lease
6Liabilities
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Seek the advice of your professional advisers as you investigate the liabilities of the
business.
Liabilities may be extensive and range from unpaid bills to back taxes to superannuation
commitments and redundancy payments.
The contract should include details of any liabilities you agree to take over, as well as a
clause to say that all claims not shown and revealed in writing at the date of purchase will
be the responsibility of the vendor.
Taxation and Finance
Check all taxation matters concerning the business, paying particular attention to whether:
there are any current disputes with the Australian Tax Office
PAYE, BAS, superannuation and other tax payments are up to date
the market value of plant and equipment is different from its written down value
the business has significant goodwill
there are any accrued holiday pay, long service leave entitlements or retirement payments
to be made
any of the vendor’s book debts are likely to become bad
any repairs need to be done
you’ll need to borrow to finance the purchase.
7Other factors
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Determine the past and future trends of the business, industry and neighbourhood
community.
Explore the history of the location and establish the type of businesses that have operated
there as well as their level of success.
Consider what the total capital requirement will be – it must be adequate to cover working
capital, repairs, modernisation, new equipment, new stock, debtors, reserves for taxes,
insurance, opening expenses, legal feeds, stamp duty plus, say, 10 per cent for unexpected
expenses.
Assess the total capital investment in relation to profitability.
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This page has been produced by the Department of State Growth. Questions or comments
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