When evaluating a business, financial statements are a critical source of information that provide valuable insights into the company’s performance and potential risks. As a business broker, I generally try to recommend to my buyers and even my sellers, to closely examine three key items.
The first element is to look at the company’s revenue trends over the past few years. Consistent growth is generally a positive indicator, while declining or erratic revenue might suggest underlying issues. Also, pay attention to any seasonal fluctuations, the concentration of revenue from a few key customers, and how revenue is recognized, such as accrual versus cash basis. Understanding these patterns helps gauge the business’s stability and potential for future growth.
Next, analyze profit margins to assess the business’s profitability. Compare how these margins have changed over time and measure them against industry benchmarks, which you can Google to get a general idea. A decline in profit margins could indicate rising costs or pricing pressure, so it is worth scrutinizing the cost structure, focusing on fixed versus variable costs, to understand how the business might perform under different revenue scenarios. This analysis can help identify opportunities for cost optimization or potential financial risks.
Lastly, review the cash flow statements to assess whether the business generates sufficient cash from operations to cover its expenses, including paying an owner, investing in growth, and servicing debt. A business might be profitable on paper, but could still face challenges if it lacks adequate cash flow or has poor liquidity management, especially if you’re using debt as part of an acquisition.
By focusing on these areas, as a buyer and seller, you can gain a comprehensive understanding of the business’s financial health, risks and opportunities involved.
