Financial Statements  - How to verify Financial Information when Buying a Business

Yes, in the perfect world, business sellers will support their financial claims about their businesses by providing tax returns. They will also provide three years financial statements signed by accountants. Well, if you have been searching for a business for a while, specifically for a business with asking price of less than $250,000, you have probably discovered that we do not live in the perfect world.

There are many reasons why financial reports are not available. First, small business owners are often too busy with running their business, and they simply don't care or don't have the time to establish good financial documentation. Second, hiring outside help to keep records for the business is usually an unnecessary and expensive cost. Finally, don't tell Uncle Sam, but some small business owners enjoy the lack of documentation. So far, I haven't told you anything that you didn't already know, right?

Have you considered, however, that the lack of financial documentation is often in the buyer's favor? Yes, I said in the buyer's favor. A business owner, who kept great financial documentation, would ask top dollars for his / her business and he can. It's like selling a car in excellent shape vs. a car with no maintenance. However, a good business broker would educate his seller that with the lack of financial documentation, the seller should lower his / her expected asking price. Therefore, lack of financial documentation means more bargaining power to the buyer. Often, buyers ask me: "what is a great business?" And my answer is: "a business with no financial documents."

So, am I asking you to buy a business blindly? Based on the good word of the seller? No, I am asking you to do a little bit of due diligence. You are going to buy a business, for crying out loud. Understand whether the business is valuable or not. You are going to spend a big chunk of your savings and most of your time on this business; start doing the work before you purchase it.

There are many ways to verify the business profitability without looking at tax returns or audited financial statements. First, I would estimate the gross sales figures. For example, you can do it by looking at daily register records or adding up checking account statements and credit card statements (credit card paid by clients). However, the best way to verify gross sales figures is actually to spend a few days and observe the business. Count clients and see how much they spend. Then, estimate how much business is being conducted. Second, I would estimate all expenses. Simply list all the different expense items, such as rent, utilities, payroll, cost of goods, advertising, etc. and add them up. Now, you can estimate the potential profitability of the business. Maybe this sounds like common sense to you, but you would be surprised by how many business buyers don't consider this simple method as the most important tool to evaluate a business. Remember, even if financial statements are available they might be misleading by overstating the true profitability of the business, so you need to do this analysis anyways.

It is important to note that financial documents are a necessity if you are applying for a loan, but that should be discussed in another article.

All told, do not be discouraged by the lack of financial statements and tax returns when looking for a business. Lack of financial statement is often a buyer's advantage. It increases the buyer's bargaining power, and encourages the buyer to do a thorough investigation of the business.

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Article written by Yuvi Shmul. Published with permission from Yuvi Shmul, YSGE LLC.