The Very-Beginner's Guide to Evaluating a Business

A Very-Beginner's Guide to Evaluating a Business: Start with the financial statements

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When you're looking to buy a business, diving into its financial statements is a bit like reading a CarFax report before deciding on a vehicle. These documents give you a snapshot of the company's financial health and performance. 

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Before you sign any checks, it's crucial to understand what these numbers tell you about the business you're considering. 

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Here are 10 important numbers to evaluate on a company’s financial statement, along with three non-financial factors to keep in mind.

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10 Financial Metrics to Evaluate

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Revenue: This is the total income generated from the sale of goods or services associated with the company's primary operations. It's important because it shows how much money the business is bringing in before any costs are deducted.

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Cost of Goods Sold (COGS): These are the direct costs tied to the production of the goods a company sells. This number helps you understand what it costs to produce the product or service, which in turn affects the profitability.

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Gross Profit: This is calculated as revenue minus the cost of goods sold. It reflects the efficiency of production and what's left over to cover other expenses.

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Operating Expenses: These expenses are related to the day-to-day functioning of the business and exclude costs associated with production. It includes rent, utilities, salaries, and marketing.

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Operating Income: Also known as EBIT (Earnings Before Interest and Taxes), this number shows the profit a business makes from its operations alone, which can be a good indicator of the company’s core profitability.

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Net Income: Found at the bottom of the income statement, this tells you what the business has earned after all expenses have been subtracted from revenues. It's often referred to as the "bottom line."

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Total Assets: This figure shows everything the company owns that has value. It includes cash, inventory, property, and equipment.

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Total Liabilities: These are all the debts the company owes, like loans and mortgages. The ratio of assets to liabilities can help assess the financial stability of the business.

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Owner's Equity: This is calculated as total assets minus total liabilities. It shows the owner's stake in the company after all debts are paid.

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Cash Flow: This tracks the flow of cash in and out of the business. Positive cash flow means more cash is entering the business than leaving, which is crucial for day-to-day operations.

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Some Non-Financial Factors to Consider

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Market Position: Understand where the business stands in its industry. Is it a leading provider, or does it struggle against competitors? Market position can influence future profitability and growth opportunities.

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Brand Reputation: A strong brand can be a significant asset. Evaluate customer loyalty, brand recognition, and the business's reputation. A good reputation can mean smoother sailing after the purchase.

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Legal and Regulatory Compliance: Make sure the business complies with all relevant laws and regulations. Non-compliance can lead to fines and legal issues that might not only cost money but also damage the business’s reputation.

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By thoroughly understanding these financial and non-financial factors, you'll be better equipped to make an informed decision about purchasing a business. Remember, buying a business is not just about the numbers; it's also about seeing the bigger picture and understanding what drives the company's success or impending struggle.

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