Buying an existing business can provide an opportunity to acquire established customers, revenue, employees, systems and assets rather than starting from scratch.

But a business that looks attractive from the outside may tell a very different story once you examine the numbers.

Before signing a contract or committing significant capital, prospective buyers should understand what they are actually purchasing, how the business makes money and whether the financial results support the asking price.

This is where financial due diligence becomes critical.

An accountant can help you examine the financial information, identify potential risks and understand whether the business is financially capable of supporting your plans.

Why Should You Check the Numbers Before Buying a Business?

A business sale may be presented using revenue, profit or growth figures that look impressive.

But headline numbers rarely tell the complete story.

Before buying, you need to understand:

• How much revenue the business actually generates
• How profitable it really is
• Whether profits convert into cash
• What the business owes
• What assets it owns
• How dependent it is on particular customers
• Whether expenses are sustainable
• Whether the financial results are consistent
• What risks could affect future performance

The objective isn’t simply to determine whether the business is profitable.

It’s to determine whether the financial performance justifies the purchase and supports your plans for the future.

1. Review at Least Several Years of Financial Statements

Start by requesting the business’s historical financial statements.

Depending on the business, these may include:

• Profit and loss statements
• Balance sheets
• Cash-flow statements
• Management accounts
• Business activity statements
• Tax returns
• Financial forecasts

Looking at several years rather than one financial year can reveal important trends.

You may discover that:

• Revenue has been declining
• Profit margins are shrinking
• Expenses have increased
• Profitability is unusually high in one year
• The business is highly seasonal
• Results have been inconsistent

A single strong year shouldn’t automatically be treated as representative of future performance.

2. Verify the Revenue

Revenue is one of the first numbers buyers usually look at, but it needs to be examined carefully.

Ask:

• Where does the revenue come from?
• Is revenue recurring or one-off?
• How many customers generate most of the sales?
• Are there seasonal fluctuations?
• Are sales increasing or declining?
• Are there unusual transactions?
• Do sales figures match the supporting records?

You should also consider whether the reported revenue is sustainable after the ownership change.

A business generating significant revenue from the current owner’s personal relationships may not retain all of that revenue once the owner leaves.

3. Understand the Business’s Profitability

Revenue alone doesn’t determine whether a business is financially attractive.

Review:

• Gross profit
• Gross margin
• Operating expenses
• EBITDA or other relevant earnings measures
• Net profit
• Net profit margin

Look at profitability over multiple periods.

A business with $2 million in revenue and a $100,000 profit may present a very different investment opportunity from a business generating the same revenue with a $400,000 profit.

You should also understand why the profit margin is at its current level.

4. Normalise the Financial Results

Reported profit isn’t always the same as the underlying maintainable profit of a business.

Financial statements can contain expenses or income that won’t continue after the acquisition.

For example, there may be:

• Owner-specific expenses
• One-off legal costs
• Unusual repairs
• Personal expenses
• Non-recurring income
• Temporary staffing costs
• Exceptional expenses

An accountant can help identify these items and determine whether adjustments are appropriate when assessing the business’s underlying earnings.

This process is often referred to as normalising the financial results.

5. Examine the Cash Flow

A profitable business isn’t necessarily a cash-rich business.

Review:

• Operating cash flow
• Customer payment timing
• Accounts receivable
• Supplier payments
• Capital expenditure
• Loan repayments
• Tax payments

Ask whether the business consistently converts its reported profits into cash.

If the business reports strong profits but regularly struggles to generate cash, you need to understand why.

6. Review Accounts Receivable

Find out how much money customers currently owe the business.

Review:

• Total outstanding invoices
• Overdue invoices
• Customer payment patterns
• Aged receivables
• Bad debts
• Credit terms

A large accounts receivable balance may look like an asset, but some of those invoices may be difficult to collect.

You also need to establish whether outstanding receivables are included in the purchase price or remain with the seller.

The treatment should be clearly understood as part of the transaction.

7. Review Accounts Payable

You should also understand what the business owes.

Review:

• Supplier balances
• Overdue bills
• Outstanding expenses
• Accrued liabilities
• Loans
• Finance arrangements
• Other short-term obligations

A business with significant unpaid liabilities may require more working capital after acquisition than initially expected.

8. Check the Business’s Debt

Identify every borrowing arrangement associated with the business.

This could include:

• Bank loans
• Equipment finance
• Vehicle finance
• Business credit cards
• Overdrafts
• Director or shareholder loans
• Other financing arrangements

Determine:

• Outstanding balance
• Interest rate
• Repayment amount
• Remaining term
• Security provided
• Whether the debt transfers with the business

Don’t assume that debt is automatically included or excluded from the transaction.

The sale agreement should clearly establish what the buyer is taking on.

9. Examine the Assets

Review the assets included in the purchase.

Depending on the business, these might include:

• Equipment
• Vehicles
• Inventory
• Technology
• Furniture
• Intellectual property
• Software
• Customer databases
• Brand assets

Consider the actual condition and value of these assets.

An asset appearing on a balance sheet doesn’t necessarily mean it is worth its recorded accounting value today.

10. Check the Inventory

If you’re purchasing a business that holds stock, inventory deserves particular attention.

Review:

• Inventory value
• Stock turnover
• Slow-moving stock
• Obsolete stock
• Damaged stock
• Inventory purchasing patterns

You don’t want to pay full value for inventory that may be difficult to sell.

Establish how inventory will be valued as part of the transaction and whether a stocktake will be performed.

11. Understand the Working Capital Requirements

Ask how much working capital the business needs to operate normally.

Consider:

• Average customer payment period
• Supplier payment terms
• Inventory requirements
• Payroll
• Operating expenses
• Seasonal fluctuations

A business may be profitable but require significant working capital to operate.

This is particularly important if you plan to grow the business after acquisition.

12. Identify Customer Concentration

Find out whether the business depends heavily on a small number of customers.

For example, if one customer represents 40% of annual revenue, losing that customer could have a significant impact.

Review:

• Top customers
• Revenue concentration
• Customer contracts
• Customer retention
• Contract expiry dates
• Customer relationships

High customer concentration doesn’t automatically make a business a bad investment, but it represents a risk that should be understood and reflected in your assessment.

13. Understand the Supplier Relationships

The same principle applies to suppliers.

Ask:

• Does the business rely on one major supplier?
• Are supplier contracts transferable?
• Are prices stable?
• Are payment terms favourable?
• Is there a risk of supply disruption?

A business that relies heavily on one supplier may face operational or margin risks if that relationship changes.

14. Review Tax and ATO Obligations

Tax obligations should be carefully reviewed before acquiring a business.

Depending on the transaction and business structure, relevant records may include:

• Income tax returns
• Business activity statements
• GST records
• PAYG withholding
• Superannuation obligations
• Payroll tax where applicable
• Other statutory obligations

You should establish whether there are any outstanding tax liabilities, disputes or unresolved issues.

The exact tax implications will depend on the transaction structure and circumstances, so professional advice should be obtained before proceeding.

15. Look for Unusual Financial Trends

Don’t simply review the total figures.

Look for changes.

For example:

Revenue: Increasing
Gross Margin: Falling
Payroll: Increasing significantly
Net Profit: Flat

This may indicate that the business is generating more sales but becoming less efficient or profitable.

Other warning signs can include:

• Rapid expense increases
• Falling margins
• Increasing debtor days
• Growing short-term debt
• Declining cash balances
• Unusual one-off income
• Large changes in working capital

The numbers should tell a consistent story.

16. Compare the Asking Price With the Financial Performance

Once you understand the financial performance, consider whether the asking price is reasonable.

Business valuations can involve several approaches, including:

• Earnings-based methods
• Asset-based methods
• Market comparisons
• Discounted cash flow approaches
• Industry-specific valuation methods

The appropriate method depends on the type of business and transaction.

Don’t rely solely on a seller’s claim that the business is “worth” a particular amount.

The price should be assessed against the business’s financial performance, assets, risks and future prospects.

17. Understand What You Are Actually Buying

This is one of the most important questions.

Are you buying:

• Shares in a company?
• Business assets?
• A customer base?
• Intellectual property?
• Equipment?
• Inventory?
• A brand?
• Contracts?
• Goodwill?

The structure of the transaction can have significant accounting, tax and legal implications.

Make sure you understand exactly what is included before committing to the purchase.

18. Prepare Your Own Financial Forecast

Don’t rely entirely on the seller’s forecast.

Build your own model based on what you believe is realistic.

Consider:

• Expected revenue
• Gross margins
• Staffing costs
• Rent
• Supplier costs
• Marketing
• Debt repayments
• Tax
• Working capital
• Your own salary or drawings
• Planned investment

Then consider different scenarios.

Base Case

What happens if performance remains broadly similar?

Growth Case

What happens if sales increase?

Downside Case

What happens if sales decline or costs increase?

This can help you understand the potential financial outcomes before you buy.

19. Calculate How the Purchase Will Be Funded

Determine how you intend to pay for the acquisition.

Potential funding sources may include:

• Personal capital
• Business finance
• Investor funding
• Seller finance
• Existing business funds
• Other approved financing arrangements

Then model the repayments.

Ask:

Can the acquired business generate enough cash to support the acquisition debt?

If the answer depends on unrealistic growth assumptions, the acquisition may carry more risk than it initially appears.

20. Consider Your Own Financial Position

Buying a business doesn’t happen in isolation.

Consider how the acquisition affects your overall financial position.

You may need to account for:

• Deposit or equity contribution
• Loan repayments
• Working capital
• Professional fees
• Transaction costs
• Initial investment
• Renovations or equipment
• Your personal income requirements

Avoid using every available dollar to complete the purchase if the business will then have insufficient working capital.

21. Get Professional Advice Before Signing

Buying a business is a major financial decision.

A professional team can help you examine areas that may be difficult to assess independently.

Depending on the transaction, you may need:

• An accountant
• A business adviser
• A lawyer
• A finance professional
• Other specialists

Your accountant can focus particularly on the financial side of the transaction and help you understand what the numbers are actually showing.

An Accountant’s Financial Checklist Before Buying a Business

Before proceeding, make sure you have considered:

• Several years of financial statements
• Revenue trends
• Gross profit and margins
• Net profit
• Underlying or normalised earnings
• Cash flow
• Accounts receivable
• Accounts payable
• Existing debt
• Assets
• Inventory
• Working capital requirements
• Customer concentration
• Supplier concentration
• Tax obligations
• Unusual financial transactions
• Business valuation
• Purchase price
• Transaction structure
• Funding arrangements
• Debt repayment capacity
• Your financial forecast
• Downside scenarios

If you cannot confidently answer these questions, you may not yet have enough information to make an informed decision.

Frequently Asked Questions About Buying a Business

What financial information should I ask for before buying a business?

You should generally review financial statements, tax records, management accounts, cash-flow information, accounts receivable, accounts payable, debt, inventory and other relevant financial records. The exact information required depends on the transaction.

How many years of financial records should I review?

Reviewing several years can provide a better understanding of financial trends, seasonality and consistency than looking at a single year. Your accountant can advise on the appropriate period for the specific transaction.

What is financial due diligence when buying a business?

Financial due diligence involves examining a business’s financial records, performance, assets, liabilities, cash flow and other financial information to identify risks and assess the financial basis of the proposed transaction.

Should I rely on the seller’s profit figures?

You should verify the figures independently. Reported profit may include one-off items or expenses that need to be adjusted when assessing the business’s underlying financial performance.

What is normalised profit?

Normalised profit attempts to show the sustainable underlying earnings of a business by adjusting for unusual, one-off or owner-specific items where appropriate.

How do I know if a business is worth the asking price?

Business valuation depends on factors including earnings, assets, cash flow, industry, risk, growth prospects and market conditions. An accountant or qualified valuation professional can help assess the appropriate valuation approach.

Should I buy a business with debt?

Debt isn’t automatically a reason to avoid an acquisition. The important considerations include the amount of debt, repayment terms, interest costs, cash flow and whether the business can comfortably service the borrowing.

When should I involve an accountant?

Ideally, involve an accountant before making a binding commitment. Early financial due diligence can help you identify issues, assess affordability and understand the financial implications of the proposed purchase.

Talk to Latitude Accountants Before Buying a Business

Buying a business can be a significant opportunity, but it is also a major financial commitment.

The business may look attractive based on its revenue or advertised profit, but the real financial picture requires a closer examination.

Reviewing the numbers before committing can help you understand the business’s profitability, cash flow, liabilities, working capital requirements and potential risks.

Latitude Accountants provides accounting, business advisory, tax planning and financial services to help Australian business owners make informed decisions.

If you’re considering buying a business and want an experienced team to help you assess the financial side of the opportunity, our team can help you understand the numbers before you commit.

Latitude Accountants

📍 Sydney Olympic Park | Marrickville | Melbourne | Loxton
📞 1300 706 597
📧 info@latitudeaccountants.com.au

Want tailored business advice? Let’s chat.

Disclaimer

This article provides general information only and does not constitute financial, accounting, tax, legal, valuation or business advice. Buying a business involves significant financial and legal considerations, and the appropriate due diligence will depend on the structure, industry, size and circumstances of the transaction. Examples and checklists provided are general in nature and may not cover every issue relevant to a particular acquisition. You should obtain appropriate professional advice before entering into a business purchase or other significant financial transaction.