Business Valuers' Masterclass - Warning Signs Mutton Dressed As Lamb!

INTRODUCTION:

With interest rates being very low, depending on who you talk to it's a great time to borrow and buy a business and get a nice healthy return on your investment right? Well, like most things this is relative to the type of business you are looking at.

We've all heard of some great stories where people have bought a business and made a fortune but as a business valuer I've also seen many sad stories where the investment was a total disaster and where some had even lost their homes.

Business valuers will look for warning signs whenever they look at performing a business valuation. Today we look at the top 6 things that will raise a red flag.

Figure 1: When it comes to buying a business, let's cut through all the rubbish!

1. Revenue Is Decreasing

A business that is showing declining revenue raises a lot of questions. Is it declining because customers are leaving? Is the business competitive? How many new customers have been acquired as opposed to those staying or going? What marketing has been done?

What is the last 3 years' comparatives of the business's growth equation:

• number of existing customers;
• number of new customers;
• average transaction spend;
• number transactions per customer per year.

2. One Off Levels Of Income Streams

When assessing the income performance, look at for one off transactions that probably won't occur again such as unusual contracts. To some extent you can also throw in large amounts of revenue being contributed by very few customers. What if they leave or close down? Be also careful of businesses that have more than one business in different locations. Income can sometimes be shown from other stores incorrectly in the business you are looking at! This may have been done accidentally or sadly on purpose with less scrupulous vendors.

Figure 2: Don't make the fatal mistake of ignoring the warning signs before buying a business!

3. Key Staff Have Just Left

If key staff have recently left you need to do some digging to find out why. What is the chance they have been head hunted by a competitor and will they take business with them? What contracts were in place to cover the risk to the business if key people leave?

Did they leave because the writing for the business was on the wall?

4. Cash Not Put Through The Books

Any business that is being bought that tells you the figures are much better because of cash not being put through the books, be very wary of. No business should be valued on income not declared as it is far too risky.

Figure 3: This bloke just realised he should have been more careful when he bought the business!

5. Industry Is Struggling

It is so important to do research about the industry before jumping in and buying into it. Look for information from public company annual reports in the same game or use research companies such as IbisWorld. Most business valuers Sydney will have access to these resources.

6. Plenty Of Profit But No Cash Flow

A business that shows plenty of profits but has very little cash flow is a major worry. Business valuers Sydney will look at key performance indicators such as:

• debtor days;
• supplier days;
• inventory days.

If profits are not being converted to cash quickly enough, growth could actually send it broke but also there is a risk that the inventory is overvalued as it is not being sold so that the value on the balance sheet is higher than what it could be sold for.

CONCLUSION: 

If you are thinking of buying a business, be careful any of the above warning signs that things might not be as good as they look.

Little Red Riding Hood worked it out and so should you!