Assessing financial health
Due diligence is vital once you decide to buy a business. In the end you should know its prospects, competitors and the market. Here are the seven steps:
- 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 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 cash flow statements:
- Know the accounts back to front before you buy
- Are there any cash flow or debtor problems?
- Are bills being paid on time?
- Who are the key creditors?
- Check annual reports (if it’s a company)
- Check income tax returns for the previous three years to give you an idea of the business’ profitability
- Check business activity statements (BAS). 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 have to pay?
- Inspect and verify that plant, equipment, fixtures and fittings are in good working order
- Ask for an asset 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
- If assets are leased, get copies of the leases
- 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
- Check if any major contracts are 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
- Investigate the reasons for the sale:
- Is the business badly managed?
- Is 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?
- How many offers have been made?
- Ask customers, suppliers and competitors for information about the business and its problems
- Check for hidden problems
- Review government regulations that apply to the business and whether it has the relevant permits and licenses it needs to operate
- Check worker entitlements that need to be made, including leave entitlements or compulsory superannuation
- Check whether workers compensation premiums are up to date
- Check if intellectual property is protected through licenses, patents, trademarks and registrations and if these rights will be passed on with the sale
- Check the lease and any agreements binding the business and ask for a copy:
- Is there a right to renew on the lease and can you exercise that option?
- If there isn’t a right to renew, could you find another suitable location?
- If you are buying a company:
- Check the Australian Securities and Investments Commission (ACCC) website for company details
- The ACCC 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
- Check the Australasian Legal Information Institute website to see if the trader has ever been taken to court
- 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. Check with local council to see if new competitors planning to start up
- 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
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).