Assessing financial health

Due diligence is vital once you decide to buy a business. Seek as much information about the purchase as possible. 

By the end of the due diligence process, you should know about the overall financial health of the business, its prospects, competitors and the market.

Most importantly, if the vendor is reluctant to provide any financial information, then warning bells should be going off.

• Step 1: Check financial statements
• Step 2: Check tax records
• Step 3: Check the assets
• Step 4: Know your customers and suppliers
• Step 5: Find out why the owner is selling
• Step 6: Check legal rights and obligations
• Step 7: Check out the competitive landscape

Step 1: Check financial statements

• Check profit and loss statements. Can the business generate enough money to provide you with a reasonable income and make a profit? Compare the rate of growth for profit, sales and costs. Are there new or increased costs you should anticipate?
• Check balance sheets, profit and loss statements, annual reports and any cash flow statements for at least the past three years. If the statements aren't audited, you'll need to verify the numbers against independent evidence, such as sales records, invoices, bank statements and loan documents.
• Check annual reports (if it’s a company).
• Check cash flow statements. Are there any cash flow or debtor problems? Are bills being paid on time? Who are the key creditors? Know the accounts back to front before you buy.

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Step 2: Check tax records

• Check income tax returns for the previous three years to give you an idea of the business’ profitability.
• Check business activity statements (BASs). Reconcile the business’ taxable income and profits with its financial statements.
• Check payroll tax records (if applicable). The business’ PAYG (pay-as-you-go income tax), GST and other tax obligations, such as payroll tax, should be up to date.
• Check stamp duty records (if applicable). Will the purchase of the business be GST free (if you are buying an ongoing business) and how much stamp duty will you be up for?

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Step 3: Check the assets

• Inspect plant and equipment. Verify that plant, equipment, fixtures and fittings are in good working order.
• Check asset lists. Ask for a list and check off physical items against it.
• Do a stock valuation or stocktake to assess the amount of stock on hand and its value as at the settlement date.
• Get insurance details to check assets are insured until settlement of purchase, and if they are leased, get copies of the leases.

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Step 4: Know your customers and suppliers

• Get a list or database of key customers, find out how loyal they are and which ones are key to the business.
• Check sales contracts to see if customers are locked in and if future business is guaranteed. Are major contracts about to expire?
• Get details of suppliers and find out if they’ll continue to trade with you, if they pay their bills on time and if there are expected cost increases.

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Step 5: Find out why the owner is selling

• Investigate the reasons for the sale. Is the business badly managed and the owner is offloading it because it isn’t making money or its prospects are poor? How long has the owner operated the business, how long has it been on the market and how many offers have been made?
• Ask customers, suppliers, and competitors. They can be a good source of information about a business and its problems.
• Check for hidden problems.

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Step 6: Check legal rights and obligations

• Review government regulations that may cover the business and whether it has the relevant permits and licenses it needs to operate.
• Check worker entitlements including leave entitlements or compulsory superannuation payments, which need to be made. Check whether workers compensation premiums are up to date.
• Assess intellectual property. Is it protected through licenses, patents, trademarks and registrations and will these rights be passed on with the sale?
• Check the lease and any agreements binding the business and ask for a copy. Check if there is a right to renew on the lease and if that option is yours to exercise. If there isn’t a right to renew, could you find another suitable location?
• Buying a company? Check the Australian Securities and Investments Commission website for company details. The Australian Competition and Consumer Commission website can tell you if the business has been subject to enforcement actions. Contact your state or territory consumer affairs agency for a record of dodgy trading. Also check if the trader has ever been taken to court by visiting the Australasian Legal Information Institute website

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Step 7: Check out the competitive landscape

• Investigate your competitors. Look at their growth, strengths, weaknesses and threat to you. Compare profitability, earnings, prices and costs if you can.
• List potential threats. Are new competitors planning to start up? Check with the local council.
• Research industry trends. Is the sector growing or slowing? What are the profit margins?
• Consider economic factors. If the economy slows down, how will this affect your business?

You can get information from industry associations, government departments and the Australian Bureau of Statistics or seek specialist advice from industry bodies, consultants and business brokers.

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Where to find out more

• ASIC company and business names search
• Australasian Legal Information Institute
• ACCC trade practices start-up checklist

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• Important information 
  As this advice has been prepared without considering your objectives, financial situation or needs, you should, before acting on the advice, consider its appropriateness to your circumstances. All products mentioned on this web page are issued by the Commonwealth Bank of Australia; view our Financial Services Guide (PDF 59kb).