Buying a Business? How do You Know the Profit is Real?

Also see Want to Sell and Did Not Keep Good Records? Now What?

You want to buy a business. You look at the Income Statement. It looks like you can make a 30% return on your investment. The seller has kept his own books. But how do you know that the Income Statement is correct?

The key is “third party verification.”

  1. Ask for the bank statements. Is the total amount of money deposited about the same as the gross sales reported?
  2. Sort down the cancelled checks. Arrange them into the various expenses: Supplies, Utilities, Payroll, and so forth. Do the various stacks add up to about the amount of separate expenses reported?
  3. If the business is retail sales, notice who the major suppliers are. Ask the seller to get a letter from the top several suppliers stating the amount of purchases the previous year. Let’s say that the sales reported are $100,000. The reported purchases are $60,000. The checks add up to purchases of about $60,000. So far this looks about right. But what if the first three letters from suppliers indicate that purchases were at least $80,000? You probably should walk away and look for another business and another seller.
  4. Reconstruct your own Income Statements from the bank statements. If you can reconcile this Income Statement with the one on which you are basing your business decision, proceed according to your good sense and judgement.