Buying a company can be an excellent strategy for an aspiring entrepreneur to own their own business without starting from scratch.
But how can you ensure you invest your money into the right business venture? Carefully evaluate the selling business’s sustainability and financial health before sealing the deal.
This article lists six financial documents you should review with your accountant when purchasing a business.
1. Profit and loss (P&L) statement
This report depicts a company’s financial performance through revenue, expenses, and net profit.
Typically, when buying a startup, you should ask for the latest P&L statement (no older than 180 days) to ensure you’re reviewing the most recent financial history.
Analyze the P&L statement of the selling company for the following:
- How much revenue is growing over the accounting periods?
- The gross profit margin for goods or services sold.
- What percentage of revenue results in net profit after all expenses?
- If the company can cover its debt interest repayments.
- How much does it repay to shareholders viz-a viz how much does it reinvest?
2. Cash flow statement
A cash flow statement is one of the most critical financial reports used to assess a company’s finances while buying. This report can demonstrate the selling firm’s ability to operate in the short and long term based on its generation and use of cash during the accounting period.
Analyze the cash flow statement of the selling company for the following:
- Identify its sources of cash.
- Its ability to pay off debts.
- Can it continue funding operating expenses as time goes on?
- Its liquidity situation.
- The amount of free cash flow generated for investment
3. Balance sheet
A balance sheet summarizes a business at a given point in time. It’s a snapshot of a company’s financial position, broken into assets, liabilities, and equity.
Analyze the balance sheet of the selling company for the following:
- What resources (assets) are available to the business?
- Its sources of capital (equity and liabilities/debt).
- If it complies with applicable regulations and reporting laws.
- Gauge its solvency and business dealings.
- Estimate its future performance.
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4. Statement of Shareholders’ Equity
A company issues this financial document as part of its balance sheet. It reports the changes in the equity held by shareholders, whether those shareholders are public or private investors.
Analyze the statement of shareholders’ equity of the selling company for the following:
- Changes in equity accounts.
- Business activities that contribute to changes in the value of the equity.
5. Management’s Discussion and Analysis (MD&A)
The MD&A accompanies a company’s financial reports. This document provides an overview of the firm’s past performance, current financial condition, and management’s future projections. It also includes a discussion of the firm’s compliance, risks, and plans, such as goals and new projects.
Although not a financial document, it offers additional context about why the selling company performed the way it did during the reporting period, aiding investors in assessing its financial health.
6. Tax returns
Request the past three to five years of tax returns from the seller.
These documents will provide important information about the selling company, including its date of formation, business address, the compensation of its officers, accounting method, and any assets and liabilities.
The final word
Deciding to buy a company is no simple matter. By analyzing the financial documents above, you will better understand the selling business’s historical performance, current financial health, and potential future outlook. These insights will aid in making an informed decision about the acquisition, assessing risks, and aligning your strategic goals with the firm’s financial trajectory.
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This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal or accounting advice in this article. If you would like to engage with Escalon, please contact us here.
