Running your own business is an exciting endeavour that gives driven individuals the opportunity to lead an entity independently. It puts them in control of the venture and makes them take charge of all its departments. Thus, every employee yearns to become an employer. Several are able to realise their dream by starting-up or acquiring an existing business.
Buying an established brand is low-risk because it comes with an extensive customer base, supplier contracts and a business plan. However, budding entrepreneurs must determine their long-term stability to ensure future success. It can be easily detected through the evaluation of the business financials. Here is how potential buyers perform the financial analysis of a company to close a profitable deal.
Determine the Profitability Ratios of the Company
You need to hire an accountant to check the profitability of a business. They begin with the profitability ratios to evaluate the financial health of the company because it establishes its sustainability. It helps to ascertain its bottom line instead of short-term profits that do not define long-term success. Profitability is calculated using the gross margin ratio and net margin ratio. The formulae are given below.
Gross Margin Ratio = Total Sales – Cost of Goods Sold / Total Sales
The gross profit margin ratio helps to assess the profits of the company after it has paid off the cost of goods sold.
Net Margin Ratio = Net Profit / Total Sales
The net profit margin ratio is used to calculate the net profit of the company per dollar of total sales.
Identify the Liquidity Ratios of the Business
When buying a business for sale in Brisbane, you need to check the liquidity. It measures the ability of the entity to pay off its short-term debts, such as loans, rent, utilities, salaries and wages, etc. It showcases the ease with which business assets can be converted into cash when it needs to pay bills.
Strong liquidity indicates the business has sufficient capital to comply with its short-term obligations, making it a viable acquisition choice. Liquidity is calculated by determining the current ratio. Its formula is as follows:
Current Ratio = Current Assets / Current Liabilities
Another metric used to calculate the liquidity of the business is known as the quick ratio. It is similar to the current ratio but leaves out inventory from current assets because it takes time to be converted into cash. Its formula is as follows:
Quick Ratio = Current Assets – Inventory / Current Liabilities
Check the Solvency Ratios of the Entity
While liquidity covers short-term debts, solvency ratios look at the ability of the business to pay its long-term debts. It helps to gauge the financial stability of the business over a long period. It is calculated using the leverage ratio, which is:
Leverage Ratio = Total Liabilities / Equity
The leverage ratio indicates the dependency of the business on debt as compared to equity. If this is high for the business, securing funds in the future can be challenging for the new owner.
Another metric for calculating solvency is debt to assets, which is given below:
Debt to assets = Total Liabilities / Total Assets
It helps identify the proportion of assets that are funded by liabilities. If it is below 1, it is a safe investment for the buyer.
Assess the Operating Ratio of the Venture
Operating efficiency is another financial metric used by accountants to understand the financial status of the business for sale in Brisbane. It showcases the ability of the entity to manage its operating expenses by reducing costs and increasing sales. The operating ratio formula is as follows:
Operating Ratio = Operating Expenses + Cost of Goods Sold / Net Sales
Calculate the Balance Sheet Ratios of the Business
Accountants use this metric to identify the return on investment generated by the entity. It utilises the following ratios:
Return on Assets = Net Profit before Tax X 100 / Total Assets
Return on Investment = Net Profit before Tax X 100 / Equity
There are some more financial ratios that are used to evaluate the financials of the business. The most basic assessment can be carried out by reviewing the financial statements and assessing the sales trends.
The seller usually makes the potential buyer sign the non-disclosure document and then provides all the historical financial data of the business for sale in Brisbane. It is a part of the due diligence process and should not be missed by the buyer to avoid getting stuck with a failing business. Hiring a professional accountant for this purpose is crucial because they also help with business valuation.
Conclusion
Buying a business for sale involves financial commitment. If the entity does not perform as expected, it can lead to deficits and bad debts. Thus, it is vital to evaluate the financials before taking the plunge.
Author: Wallace Peter
Wallace Peter is a seasoned writer with a passion for sharing stories and insights about all things Australia. From its dynamic business environment to its thriving real estate market, Wallace delves into topics that capture the essence of the country. With years of experience, Wallace has developed a knack for exploring Australia’s vibrant culture, startups, lifestyle trends, and iconic destinations. In this profile, he shares valuable insights on market trends, financial planning, and entrepreneurial strategies, alongside practical tips for navigating Australia’s diverse industries. Whether you’re a resident or an explorer, Wallace’s in-depth knowledge and engaging content aim to inform, inspire, and help readers make the most of everything Australia has to offer.
