When considering buying an existing business instead of building one from scratch, there are a lot of things that you must get a handle on:
- Does the business fit your lifestyle and personality
- Does the business have a good reputation in the community
- Are the employees loyal
However, one of the most often overlooked aspect of buying a business is making sure the business can sustain profits once you take over as well as making sure the purchase price makes sense. The only way to do this is to make sure you have a really good understanding of the current finances of the business and what things could negatively impact future profits and build this into the offered purchase price. There are some key items to look at:
- Inventory – Do not pay for obsolete or damaged inventory. It has no value. Make sure to have it appraised.
- Furniture, Fixtures, Equipment and Building – Get a list in writing from the seller of the things that will be included in the sale. You do not want to assume something detrimental for the business is included in the sale and it turns out it is not.
- Copies of all contracts including leases – Make sure there are no escalation clauses that increases the speed or amount of payments on the transfer of business ownership. You also want to make sure any business contracts can transfer to you, the new owner.
- Tax Returns – Use to get an understanding of what personal expenses have been running through the business to get a handle on true business expenses.
- Financial Statements and Payroll Records – Review to get an understanding of the salary levels the owner paid him or herself. If you decide to not be hands on in the business you will have to pay someone to do the work the previous owner was doing, which will impact profits.
- Sales Records – Use to get a snapshot of the seasonality of the business. Seasonality is the ups and downs in sales due to factors that impact the business sector such as the weather for bathing suit retailers. Cash flow needs will be higher in slow months and this could factor in your profitability.
All this information as well as customer demographics should be used to create a financial model to estimate future profits of the business. Once this is known, a purchase price can be determined.
If you are a little confused or just too busy to build your own financial model to help you forecast the future profits of the business you want to buy, Loftis Consulting can help. Loftis Consulting can take the financial information and business sector trends to develop a financial forecast for that business to help you set the right purchase price.
Give Loftis Consulting a call today to schedule an appointment at (312) 772-6105.
01.26.15 | Quick Primer on Financial Projections
All business plans require financial projections. Financial projections should be based on your business’ specific needs not some generic plan pulled from the internet and are needed for both for profit and not for profit businesses since all businesses, no matter the type, need cash to operate.
When I talk about financial projections it is not numbers thrown on a page but financial statement projections in the form of an Income Statement, Balance Sheet and Cash Flow Statement. An investor or lender needs to understand how the business will make money, how the business will use the money it earns and how the business will use the money that was invested in it or lent to it. They can get a better understanding when financial projections are presented.
Let’s review the major financial statements:
The Income Statement
The Income Statement is also known as the P&L (profit or loss statement) because it shows whether or not the business made any accounting profits in the past. The projected Income Statement will show based on your assumptions, whether or not the business will make an accounting profit in the future. The Income Statement is made up of revenue from sales of products or services and operating expenses such as cost of goods sold, wages rent and so on. The difference between revenue and operating expenses is operating profit or loss. If revenue is higher than expenses then you have a profit. In turn if operating expenses are higher than revenue then you have an operating loss.
When creating a projected Income Statement, the assumptions you make are key. The assumptions should be driven by your business. For example, years ago I worked for a hot cereal manufacturer who could project sales of oatmeal by how cold the winter was forecast to be. The first rule of developing projections is to be sure to understand the drivers of your business on the revenue side and the expense side. Again, once you compare your projected expenses against projected revenues you will know if your business plan will show an accounting profit or loss. Please note that accounting profit is not the same as cash in the bank. From an accounting perspective, a business can be profitable on paper but have negative cash flow. This is why the Cash Flow Statement is such an important financial statement.
The Cash Flow Statement
You may be wondering how the Income Statement can show profit but the business has a negative cash position. An example:
Your clients buy your product but will not pay until 30 days later. From an Income Statement perspective, you’ve earned the money and provided the product or service and thus have revenue reflected on your Income Statement; however, the cash has not yet come in the door. As a result, your cash position is negative since you have expended all the resources to get the product or service to the client but no cash has yet been received.
The Cash Flow Statement answers four key questions:
- Is cash generated from the core operations of the business
- Did the business reinvest in itself (e.g. purchase equipment, buy a building) or sell some of its assets off
- Did the business get outside financing through bank loans and/or investors
- Is the business cash positive
In order to complete the Cash Flow Statement, the Income Statement and Balance Sheet must be completed.
The Balance Sheet
The Balance Sheet shows the company’s financial position at a point in time. It shows assets (e.g. cash, equipment), liabilities (loans) and equity (investments in the business from others, owners and business profits). The business profits in equity represent the profits of the business since it opened less any distributions to owners or other investors.
By projecting out these three financial statements, it will allow you to not only tweak your business model for optimal performance but help you get a better understanding of your business and maybe get some investors or bank loans in the process.
In the process of completing your own financial statement projections, Loftis Consulting can help. We offer financial statement projection review services as well perform financial statement modeling services. Contact Loftis Consulting today at (312) 772-6105 or firstname.lastname@example.org.
08.26.13 | Introduction to Business Models
I came across this excellent white paper entitled Building Resilence – Introduction to Business Models that discusses in detail the concept of business models. In the business world we throw this term around loosely but this white paper produced by CGMA does a great job of breaking down different aspects of business models from not only the financial perspective but also from the perspective of human capital, industry sector and so on. If you are in the process of updating your own business model or strategic plan this white paper is an excellent resource.
Let me know what you think.
Building a good financial model isn’t easy but is so important to raising capital for your business. Many companies spend many hours trying to get their financial model just right. The reason – – – to provide potential investors information on the company’s projected financial performance in the hopes of garnering an investment and to show that the strategy (i.e. use of dollars for such things as marketing, inventory or staffing) translate into financial gain in a reasonable period of time for that particular industry.
The model should provide the details of the big picture that the company is pitching. The key assumptions that are the drivers of the financial model are critical to understand thoroughly as well as communicate to potential investors. In addition, if you key drivers don’t make sense to investors then your pitch will not be deemed credible. In order to ensure that your pitch is credible and in essence your financial model makes sense, make sure to test the following items when your model has been completed BEFORE sending to anyone externally.
First Test: Make sure cash flow makes sense
In your cash flow model, you must make sure to account for when cash from sales is actually received rather than when earned and when money is actually paid out for expenses. Many models assume that when a sale occurs the business receives the money at the same time. However, this may be the scenario for a consumer-oriented brick and mortar retail store but not the case for an online retail store using a 3rd party sales portal to hock its products. The 3rd party may wait for 30-days or more to pay out monies for sales. In the meantime while you are waiting for those funds, employees need to get paid and other bills are arriving in the mail. Your cash flow statement and balance sheet must take these in and out flows of cash into account. By including this information, you show potential investors that you understand cash flow and are not a complete idiot.
Second Test: You don’t account for income taxes
Most models for early stage or start-up companies show significant losses during the first years of business operations. For the years there were losses, there is no tax liability. However, when you start making a profit, there may or may not be a tax liability for the first several years depending on the earlier losses. Make sure to take into account your net operating losses from the early years when calculating future tax liabilities in the profitable years.
Taxes can be complicated so make sure to talk to a tax professional to get an understanding of your state and federal tax liabilities as well as the standard tax rate for your industry.
Third Test: Sales forecasts are based on reliable data not a percent of the market
From an investor presentation standpoint, it makes sense to present your business as garnering a certain percent of the market over a specified time period in order for the investor to understand the size of the opportunity. However, you should not build your business model on a percentage of the market assumption.
Sales should be calculated from a bottoms-up approach. This means calculating your sales based on your sales process and cycle. If you did a good job building out your key drivers (i.e. assumptions) of your business model, this should not be difficult to do. Examples of key drivers include:
- How long does it take to close a sale?
- What is the capacity per sales person to reach leads?
- What is the percentage of leads that turn to sales?
- What percentage of online referrals convert to paying customers?
The list can go on and on but is dependent on knowing your sales process and cycle to make it credible.
At the end of the day it is you who is selling yourself and the company to investors. You need to understand the key drivers of your business model and explain them both strategically and financially. If you need help with the financial part, then get help. You want to be credible to potential investors.
Loftis Consulting provides affordable financial model review services and custom built financial models for start-ups. To learn more how we can help you build a better model, contact us today at email@example.com.