Business Appraisal – Buying a Company

Analyzing the Cash Flow Statement for Purchasing a Small Business

Oct 17, 2009

An important consideration when buying a small business is the financial strength of the company. Analyze the financial statements prior to purchasing a business.

There are many considerations when buying a small business. One of the most important considerations is the financial stability and strength of the company that’s being purchased. Analyzing the financial statements enables the buyer to determine the financial position related to their personal investment. The three financial statements that should be analyzed prior to buying a small business are the income statement, balance sheet and the statement of cash flows.

Buy a Business – The Statement of Cash Flows

The different financial statements allow a business to stop in time and take a snapshot of the company’s financial strength. Financial statements can be completed monthly, quarterly or yearly. The cash flow statement is an important report because it shows the company’s ability to generate cash. Just because a business can generate profits, as evident by the income statement, doesn’t indicate the cash position of the company.

Analyzing the Cash Flow Statement to Buy a Business

Almost every small business sells a product or service that doesn’t generate immediate cash. The accounts receivable general ledger and subsidiary ledgers usually control sales that don’t generate immediate money. If a business has a large portion of its revenues in accounts receivables with a slow turn-over-rate, it could have a detrimental affect on cash flow.

Over purchase of an asset like inventory can have a detrimental affect on cash flow. If money is going out to purchase inventory that isn’t turning fast enough, purchasing too much inventory won’t be displayed on an income statement, but can be determined by analyzing the statement of cash flows along with the balance sheet.

Negative Cash Flow Considerations

Negative cash flow means that the company has more cash going out than it has coming in. If the business has more money going out than coming in, careful consideration should be made to the financial strength of the company. What are some of the reasons for a negative condition?

If a business is experiencing poor cash flow performance, analyzing the various financial statements along with other reports may show the root cause(s) of the poor performance. Once the root cause(s) are determined and the income statement shows a consistent profit, negotiations with the seller maybe able to offset poor performing cash flow.

If there’s too much debt, the seller may assume some of the debt. If idle inventory is a problem, don’t purchase the idle inventory. If the buy/sell negotiations can’t negate a cash flow problem, than the purchase of the company should not be undertaken.

The copyright of the article Business Appraisal – Buying a Company in Small/Home Business is owned by James Clausen. Permission to republish Business Appraisal – Buying a Company in print or online must be granted by the author in writing.