Following is a checklist of items you should evaluate to verify the value of a business before making a decision to buy:
1. Inventory - Refers to all products and materials inventoried for resale or use to service a client. Important note: You or a qualified representative should be present during any inventory proceedings. You should know the status of inventory, what's on hand at present, and what was on hand at the end of the last fiscal year and the one preceding that. You should also have the inventory appraised.
2. Furniture, fixtures, equipment, and building - This includes all products, office equipment and assets of the business. Get a list from the seller that includes the name of each piece of equipment and model number. Then determine its present condition, market value when purchased versus present market value, and whether the equipment was purchased or leased.
3. Copies of all contracts and legal documents - In terms of contracts, this would include all lease and purchase agreements, distribution agreements, subcontractor agreements, sales contract, union contracts, business employee agreements and any other instruments used to legally bind the business. Also, evaluate all other legal documents such as fictitious business name statements, articles of incorporation, registered trademarks, copyrights, patents, etc.
4. Incorporation - If the company is a corporation, check to see what state it's registered in and whether it's operating as a foreign corporation within its own state.
5. Tax returns for the past five years - Many small business owners make use of the business for personal needs. They may buy products they personally use and charge them to the business or take vacations through the company, go to trade shows with their spouses, etc. You have to use your analytical skills and those of your accountant to determine what the actual financial net worth of the company is.
6. Financial statements for the past five years - Evaluate these statements through the last five years to match the tax returns, including all books and financial records. The sales and operating ratios should be examined with the help of an accountant familiar with the type of business you are considering.
7. Sales records - Although sales will be logged in the financial statements, you should evaluate the monthly sales records as well for the past 36 months or longer. Break sales down by product categories if several products are involved as well as cash and credit sales. This is a valuable indicator of current business activity and provides you with some understanding of cycles that the business may go through.
8. Complete list of liabilities - Consult an independent attorney and accountant to examine the list of liabilities to determine the potential costs involved and legal ramifications.
9. All account receivables - Break down by 30, 60, 90 days and beyond. Checking the age of receivables is important because the longer the period they are outstanding, the lower the value of the account. You should also make a list of the top 10 accounts and check their creditworthiness.
10. All account payables - Like account receivables, account payables should be broken down by 30, 60, and 90 days. This is important in determining how well cash flows through the company, but also on payables beyond 90 days, you should check to see if any creditors have placed a lien on the company's assets.
11. Debt disclosure - This includes all outstanding notes, loans and any other debt to which the business has agreed.
12. Merchandise returns - Does the business have a high rate of return? Has it gone up in the past year? If so, can you isolate the reasons for returns and correct the problem(s)?
13. Customer patterns - If this is the type of business that can track customers, you will want to know specific characteristics concerning current customers such as: How many are first time buyers? How many customers were lost over the past year? When are the peak buying seasons for current customers? What are low median price points? Average median price points? High median price points? What type of merchandise is the most popular?
14. Marketing strategies - How does the owner obtain customers? Does he or she offer discounts, advertise aggressively, or conduct public-relations campaigns? You should get copies of all sales literature to see the kind of image that is being projected by this business.
15. Advertising costs - Analyze advertising costs. Many times it pays for a business at year-end to postpone that profit until the next year by spending a lot of money on advertising during the last month of the fiscal year.
16. Price checks - Evaluate current price lists and discount schedules of all products, the date of the last price increases, and the percentage of increase.
17. Industry and market history - Analyze the industry as well as the specific market segments the business targets. You need to find out if sales in the industry, as well as the market segment, have been growing, declining, or remained stagnant. This is very important to determine future profit potential.
18. Location and market area - Evaluate the location of the business and the market area surrounding it. This is especially important to retailers who draw the majority of their business from the primary trading area.
19. Reputation of the business - The perceived image of the business by customers as well as suppliers is extremely important. As we mentioned, the image of the business can be an asset or a liability. Interview customers, suppliers, the bank, as well as owners of other businesses in the area to determine the reputation of the business.
20. Seller-customer ties - You MUST find out if any customers are related or have any special ties to the present owner of the business. How long has any such account been with the company? What percentage of the company's business is accounted for by this particular customer or set of customers? Will this customer continue to purchase from the company if the ownership is changed?
21. Inflated salaries - Some salaries may be inflated. The owner may have a relative on staff who isn't working for the company. All of the possibilities should be analyzed.
22. List of current employees and organizational chart - Current employees can be a valuable asset, especially key personnel. Evaluate the organizational chart to understand who is responsible to whom.
23. OSHA requirements - Find out if the facility meets all occupational safety and health requirements, and whether it has been inspected. If you feel that the seller is "hedging" on this and you see some things you feel might not be safe on the premises, you can ask the Occupational Safety and Health Administration (OSHA) to help you with a check.
24. Insurance - Establish what type of insurance coverage is held for the operation of the business and all of its properties, the underwriter and local company representative, and how much the premiums are.
25. Product liability - Product liability insurance is of particular interest if you are coming into a manufacturing company. Certain insurance coverages dramatically change from year to year, and this can markedly affect the cash flow of a company.
This text was excerpted from "Entrepreneur Magazine's Small Business Encyclopedia." Get your own personal edition of the Small Business Encyclopedia. Now available in the SOHO Mall.