Owning or investing a business can be a great way to earn a living and be your own boss. One way to own a business is to purchase an existing business. That one already has a product or service that it provides and a client list. When you are looking to buy a new business, there is a lot of work that needs to be done to ensure that it is a good investment. This includes the due diligence checklist that we will analyze below.
When you are looking to invest in, or buy an existing business, there are a lot of different factors and pieces of information that you need to analyze. To ensure you make the best investment possible, it is important that you follow the below due diligence checklist. Following this due diligence checklist will ensure that you have properly assessed the transaction. Also, you gain a strong understanding of the company that you are buying.
4 Basics of the Due Diligence Checklist You Should Know
1. Review Income Statement and Trends
When you are looking to buy a new business, the first part of the due diligence checklist will include reviewing the company’s income statement. The income statement is a financial report that will provide all of the income and expenses for the company.
- When you are reviewing the income statement, you should plan on reviewing it for at least the past few years. This will help to give you a good sense of whether the business is trending in the right direction, or if it appears to be stagnating.
- You also need to review the reports to get an understanding of the sources of revenue. Ideally, the company that you are buying will have a well-diversified set of clients. This can provide you comfort that the business is not dependent on just one client or relationships.
- If one client does make up a sizable piece of that company’s business, you will need to do more due diligence on that individual client as well.
- Moreover, you should spend time reviewing the operating expenses of the company. You should focus on whether or not the expenses seem to be stable. Now, you should discover whether there are obvious expenses that could be cut.
- In many cases, small business owners will run personal salaries and other expenses through the business. But you should be able to eliminate this and boost your cash flow. Furthermore, there may be operating and vendor contracts that could be negotiated to help you save even more.
2. Look Into the Balance Sheet and Related Reports
When you are preparing a due diligence checklist for the acquisition of a business, it is also important that you spend time reviewing the company balance sheet. A balance sheet is a point in time snapshot that provides you with an idea of the overall strength of the company. The balance sheet will provide you with a statement of the assets, liabilities, and net worth of the company. In many cases, when you buy a business, you will also be assuming the balance sheet of the organization, so understanding it is very important.
- When you are reviewing the balance sheet, you should focus on the assets first. The key assets are the cash positions, accounts receivables, and the core assets. Ideally, the business will have some liquidity to operate. If there is cash on the balance sheet, your purchase agreement should prevent the owners from distributing the cash.
- You should also review the business A/R reports to ensure that there are not a lot of past due collections. If they are there, it could require you to take a big write-off.
- You should also focus on the debts. If there are lines of credit or term loans, you will need to carefully review the agreements with the lenders. This will include understanding whether the company is in good standing with the banks and what the remaining term of the loan is. Ideally, you should be able to start negotiating a refinance with the bank before you even close on the company purchase
3. Analyze the Cash Flow Statement
When you are going through the due diligence checklist, you should also analyze the cash flow statement. The cash flow statement will give you a picture of cash that has come in and left the business in a given period of time.
Unlike an income statement that can be based on accrual accounting, a cash flow statement will not account for sales that have not yet been collected. By reviewing this, you will have a better sense of what the true revenue collections are for the business over a period of time.
4. The Reputation Assessment
When you are looking to purchase a business, another important component of the due diligence checklist will be the reputation assessment. Financial statements can be easy to obtain and review. But completing a full reputation assessment can be more of a challenge. The reputation of the company you are buying is extremely important. This will have an impact on your ability to find new clients, retain existing relationships, raise capital and debt, and negotiate vendor contracts. When you are looking to complete a reputation assessment, there are several steps that can be taken.
- Some of the most effective ways to gauge a reputation is to call the company’s top clients and vendors. This will help to give you a sense of the overall level of satisfaction from all parties.
- You should also spend time running background checks on key employees.
- Complete Internet searches to see if there is any negative information that you should be aware of prior to the purchase.
Besides the upsides that come with buying a business, there are also plenty of risks involved. To ensure that your investment is successful, you should follow a due diligence checklist.
This will help to ensure the financial position and reputation of the organization you are buying is strong.
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