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Lane
Lane, JD, CFP, MBA, CRPS
Category: Finance
Satisfied Customers: 10432
Experience:  Law Degree, specialization in Tax Law and Corporate Law, CFP and MBA, Providing Financial & Tax advice since 1986
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If I am looking at purchasing an established business may I

Customer Question

if I am looking at purchasing an established business may I ask what steps that an accountant should take to ensure the business is financially viable long term? also if figures and the business accountants details are supplied is the accountant responsible to check the figures are correct with the taxation department? and are they to supply a due dillegance report on the business?
thanking you so much for your assistance
Submitted: 1 month ago.
Category: Finance
Expert:  Lane replied 1 month ago.

Hi Rex. My name's Lane ... I can help here.

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Ideally, you should talk to a credentialed business valuation professional. One of the primary reasons being that they will know the norms that have evolved over time for valuing different types of businesses.

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For example, a dental or Medical Practice - if we're just talking one or two Docs, as opposed to a large group that's run more like a business and has their own continuity plans where patients are used to seeing on of many doctors - the norm is only a year or two of income ... because the idea is that there's no assurance that the patients will stay.

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However, with a large group, where there's more predictability of continued revenue, we get closer to the classic cap rate method - where income is capitalized (divided by a number that represents the return a like kind companies generating the same level of profits sell for).

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The basic idea behind capitalizing income is that a buyer can either buy a stream of income from a business or can invest the dollars he has to invest in an alternate investment.

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As an example, if I can get 100,000 per year on a 3% long term bond with my 1,000,000 investment ... if I can find a business whose income stream is that steady and predictable then I'd divide .03 into that income to get a comparison. (3mil+ gets me that 100,000 ... 3,333,333 to be exact)

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SO another business that's driving that much PROFIT ... IF it's predictable and can be expected to continue at that level is worth 3MM+

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In terms of whether the business is viable, long-term this isn't really an accounting question (not the long term part anyway) becasue that has to do with demand for the product, longevity of income streams (having long term contracts, for example, such as we see with triple net leases in Real Estate - or having a contract and strong relationship as a supplier to a major corporation.

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In term simply of financial strength and solid operation CURRENTLY, finance pros look, generally, at four types of ratios that express relationships between financial statement items.

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(These ratios aren't generally meaningful as standalone numbers, but they are meaningful when compared to historical data and industry averages)

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Liquidity Ratios indicate a company's ability to pay its short-term bills. The most common liquidity ratio is the current ratio, which is the ratio of current assets to current liabilities. Generally, a ratio of greater than one is usually a minimum because anything less than one means the company has more liabilities than assets.

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Solvency ratios indicate financial stability because they measure a company's debt relative to its assets and equity. A company with too much debt may not have the flexibility to manage its cash flow if interest rates rise or if business conditions deteriorate. The common solvency ratios are debt-to-asset and debt-to-equity ...

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Debt-to-asset ratio is the ratio of total debt to total assets, and debt-to-equity ratio is the ratio of total debt to shareholders' equity, (which is the difference between total assets and total liabilities).

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Next we have one of the more obvious, Profitability. Profitability ratios indicate management's ability to convert sales dollars into profits and cash flow. The common ratios are gross margin, operating margin and net income margin. (Again you should see what the standards are for a like kind company and see where a business you're looking at stacks up).

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One of the more important of these is The return-on-investment ratio, which is the ratio of net income to shareholders' equity, indicates a company's ability to generate a return for its owners (This relates back to the valuation discussion I gave you above. UNLESS we have some way of selling off assets, generally we are buying a business for the income it generates

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And finally, there are the efficiency ratios; Two common efficiency ratios are inventory turnover and receivables turnover. Inventory turnover is the ratio of cost of goods sold to inventory. A high inventory turnover ratio means that the company is successful in converting its inventory into sales. The receivables turnover ratio is the ratio of credit sales to accounts receivable, which tracks outstanding credit sales. A high accounts receivable turnover means that the company is successful in collecting its outstanding credit balances.

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In terms of CPA review... you need to be aware of the terminology that CPA's use for preparing financials and "checking those figures."

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So when you talk to a firm your showing that you understand these levels will not only help communication but help to hold them accountable:

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An audit provides the highest level of assurance on an organization’s financial statements. An audit provides assurance that an organization’s financial statements are free of material misstatement and are fairly presented based upon the application of generally accepted accounting principles.

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A review provides limited assurance on an organization’s financial statements. During a review, inquiries and analytical procedures present a reasonable basis for expressing limited assurance that no material modifications to the financial statements are necessary; they are in conformity with generally accepted accounting principles. This “does it make sense” analysis is useful when the organization needs some assurance about their financial statements, but not the higher level of assurance provided by an audit.

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Then there's the compilation, whichreal provides no real assurance on an the financial statements. The CPA takes financial data provided by the firm and puts them in a financial statement format.

Expert:  Lane replied 1 month ago.

Please Let me know if you have ANY questions, before rating me.

But if this HAS helped, and you don’t have more questions on this, I’d appreciate a positive rating (by using those stars on your screen, and clicking submit) … Otherwise JA won’t compensate me for the work.

Thank you,

Lane

I have a Law degree with concentration in Tax , Estate & Corporate Law, … an MBA, with specialization in finance … a BBA, and CFP & CRPS designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice, since 1986.