You are investigating a business that you like, and the seller hands you income tax forms that show a $50,000 profit. "Of course," he says with a wink and a nudge, "I really made $150,000." What do you do?
There may be perfectly legal reasons for the lower reported income. For instance, if the seller gave his nephew a nonessential job for $25,000 a year, you can just eliminate the job and keep the cash. Same goes for a fancy leased car. One-time costs of construction or equipment may have legitimately lowered net profits, too.
What to watch for: a situation where the seller claims he or she made money but just didn't report it to the IRS. If this happens, either walk away from the deal...or make an offer based on the proven income.