Buying a business can be a financial landmine if you're not careful—one wrong move and it can cost you everything!
If you dive in without a clear understanding of the business's finances, you’re at risk of making a costly mistake.
However, asking the business owner the right questions can help reveal its true value, potential risks, and future profitability.
In this article, we’ll guide you through the critical financial questions to ask the current owner, highlight what answers to expect, and red flags to watch for.
This will help you evaluate the business’s health and avoid hidden problems.
Let’s do this…
Financial Statements and Profitability Questions:
Reviewing financial statements will give you an accurate picture of the business’s financial performance.
This includes its past, its current financial health, and its ability to generate future profit.
Ask the following questions to assess the business’s profitability and financial stability:
1. Can you provide the last three years of financial statements (balance sheet, income statement, and cash flow statement)?
Here, the owner should provide you with accurate, well-organized financial records for at least the past 3 years. These should include detailed balance sheets, profit and loss statements, and cash flow statements that show a clear, consistent picture of financial performance.
If the owner is unwilling or unable to provide comprehensive financial statements or provides incomplete or poorly organized documents, it could indicate financial mismanagement or potential hidden issues.
2. What are the key drivers of revenue for the business?
The owner should be able to identify clear and consistent sources of revenue, such as a core product, service, or client base that drives most of the business income.
If the revenue sources are vague, overly dependent on a single customer, or have been inconsistent, you could be looking at a fragile business model.
3. What is the current profit margin, and has it been stable over time?
The owner should present you with a realistic profit margin, explain any fluctuations, and demonstrate that profit margins have been reasonably stable, with gradual improvements or adjustments to changing market conditions.
If the profit margin is significantly low or has been deteriorating without a clear, justifiable reason (like rising costs or a temporary dip), this could indicate operational inefficiencies or declining market demand.
4. Are there any seasonality trends in the revenue or expenses?
The owner should disclose if the business has seasonal cycles that affect cash flow or profitability and explain how they manage these fluctuations.
If they do not acknowledge any seasonality or they’re unaware of such trends, they may lack the insight needed to manage cash flow effectively.
5. What are the business's fixed and variable costs?
The owner should take you through a clear breakdown of fixed costs (e.g., rent, salaries) and variable costs (e.g., production costs, raw materials), along with an understanding of how these impact profitability.
A vague or incomplete answer regarding costs can indicate poor financial planning or a lack of awareness of operational inefficiencies.
6. Can you provide a detailed breakdown of outstanding debts, loans, and liabilities?
The owner should provide a transparent breakdown of all financial obligations, including short-term and long-term debts, lines of credit, and any liabilities related to the business.
If you feel the seller is being evasive or unclear about debts or obligations, it may indicate hidden liabilities or the business may be over-leveraged.
Cash Flow and Liquidity Questions:
FACT: Cash flow is the lifeblood of any business. It determines the ability to pay bills, invest in growth, and weather economic challenges.
Without proper liquidity, even profitable businesses can face serious problems.
Asking these questions will help you understand the company’s cash flow situation, the timing of payments, and any potential liquidity risks.
7. What is the business’s cash flow situation?
The owner should provide clear information on how cash flows in and out of the business, including details on operating cash flow, net cash flow, and any past or ongoing cash flow challenges.
If the business has frequent cash flow problems, such as delayed payments or insufficient reserves, it could indicate poor financial health or trouble managing liquidity.
8. What are the typical days sales outstanding (DSO) and days payable outstanding (DPO)?
The owner should be able to explain their average DSO (how long it takes to collect receivables) and DPO (how long it takes to pay suppliers), with numbers that reflect industry norms.
Excessively high DSO or low DPO can indicate cash flow problems, poor credit management, or strained relationships with customers or suppliers.
9. Have there been any cash flow issues in the past year?
Ideally, the seller should be upfront about any temporary cash flow issues, explaining the causes and the steps taken to resolve them.
If the owner denies any cash flow problems or provides unclear answers, it might suggest the business is struggling with liquidity but the owner is hiding it.
Valuation and Price Justification Questions:
These questions will help you understand how the asking price was calculated and whether it aligns with industry standards and the company's actual value.
10. How did you arrive at the asking price for the business?
The owner should have a clear and logical rationale for the asking price, based on financial performance, market comparables, and industry multiples (e.g., based on EBITDA or revenue).
If the price seems arbitrary or inflated without a detailed explanation, it could indicate an overvalued business.
11. What multiple of earnings or revenue is the business being valued at?
The owner should provide the multiple used, and you should verify that it aligns with industry standards for similar businesses (typically 3-5x EBITDA, depending on the industry).
If the multiple is significantly higher than the industry average or lacks justification, it could indicate an inflated valuation or over-optimistic expectations.
12. What assumptions were made in the financial projections?
The owner should provide detailed assumptions behind future revenue, expenses, and profit projections, including growth rates, market trends, and any strategic initiatives.
Vague or overly optimistic assumptions that are not backed by data or historical trends can be a warning sign that the projections are unrealistic.
Tax and Legal-Related Questions:
Ask the following questions to ensure the business is free from tax or legal issues that could complicate the acquisition or create future costs.
13. What is the business’s current tax situation? Are there any outstanding tax liabilities or audits?
The owner should provide details on the business’s tax status, including any outstanding taxes or ongoing audits, and show that the business is in good standing with tax authorities.
If the owner is evasive about tax issues or there are outstanding liabilities or audits, it could indicate significant hidden financial risks.
14. Has the business been in compliance with all tax and regulatory requirements?
The owner should confirm that the business is up-to-date on tax filings, licensing, and other regulatory requirements.
If the business has non-compliance issues or unresolved regulatory violations, you may inherit significant legal and financial risks.
15. Are there any pending lawsuits or legal disputes involving the business?
The owner should provide full transparency regarding any ongoing legal issues, including lawsuits, claims, or disputes.
If there are unresolved lawsuits or a history of litigation, it could signal underlying risks that may affect the business’s value and future operations.
Accounts Receivable and Payable Questions:
These questions will help you evaluate the state of accounts receivable and payable, as well as any risks to cash flow.
16. What is the current state of the business’s accounts receivable and accounts payable?
The owner should provide up-to-date details on outstanding receivables (money owed by customers) and payables (money owed to suppliers), including any aging accounts or overdue balances.
High levels of overdue accounts receivable or overdue payables could indicate cash flow issues or problems with customer collections and supplier relationships.
17. Do any key customers or vendors have special payment terms?
The owner should disclose any special payment terms or arrangements with key clients or suppliers.
If there are unusually long payment terms or dependencies on a small number of clients, it could be a sign that the business is vulnerable to cash flow shocks if those customers delay payments or leave.
18. Have any customers or vendors indicated dissatisfaction or any risk to the relationship?
The owner should provide honest insights into the business’s relationships with customers and suppliers, including any potential risks or concerns.
If the owner is evasive or unaware of dissatisfaction from key customers or suppliers, it could indicate a lack of communication or looming risks in these relationships.
Inventory and Assets Questions:
The following questions will help you evaluate the business’s inventory management and asset base.
19. Can you provide a detailed inventory list, including the valuation of stock, equipment, and intellectual property?
The owner should provide an accurate, up-to-date inventory list with valuations for any tangible assets (e.g. stock, real estate, machinery, etc.) and intangible assets (e.g. intellectual property).
If the owner is vague or unable to provide an inventory list or asset valuation, it could signal problems with asset management or missing records.
20. What is the turnover rate for inventory?
The owner should be able to explain how quickly inventory is sold or used, with a reasonable turnover rate based on industry standards.
Slow-moving inventory could tie up capital and indicate poor sales or excess stock.
If the turnover rate is high, it could mean the business is facing supply chain or demand issues.
21. Are there any leased or rented assets, and if so, what are the terms?
The owner should explain any lease agreements, including rental terms, durations, and costs associated with leased assets.
If the lease terms are unfavorable, or the business is locked into long-term agreements that are difficult to change, it could indicate that fixed costs are too high or inflexible.
Employee and Compensation Considerations:
Employees are often a business’s most valuable asset. Understanding the compensation structure, employee turnover, and key contracts can help you assess the operational risks and costs associated with the workforce.
These questions will give you a clear picture of the business’s payroll and employee-related obligations, which can affect both short-term profitability and long-term growth.
22. What is the current payroll structure, including employee benefits and incentives?
The owner should provide details on salary levels, bonuses, commissions, benefits, and any employee incentive programs.
If the business has an unbalanced payroll structure, with high costs relative to profitability or a lack of clarity about employee compensation, it may signal financial mismanagement.
23. Are there any employment contracts or non-compete agreements in place?
The owner should disclose any key employee contracts, including non-compete clauses, that could affect business continuity post-sale.
If there are restrictive contracts that could be difficult to uphold or that limit hiring flexibility, it may hinder future growth.
24. Are there any issues with employee turnover or satisfaction?
The owner should be honest about employee morale, turnover rates, and any known staffing challenges.
High turnover or widespread employee dissatisfaction could signal underlying operational or management problems that may affect business performance after acquisition.
Questions About Customer Base and Market Trends:
The following questions will help you assess customer retention, market demand, and any potential risks or opportunities in the customer base.
25. What is the customer retention rate, and how diversified is the customer base?
The owner should provide clear information about customer loyalty and whether the customer base is diversified across various industries or geographic regions.
A high dependence on a few customers or a low retention rate indicates potential volatility in revenue and could pose a major risk.
26. Are there any trends in customer behavior or market demand that could affect the business in the near future?
The owner should be aware of any market shifts, technological changes, or consumer behavior trends that could impact the business's future growth.
If the owner is unaware of these trends or downplays them, it may suggest a lack of foresight or planning for future challenges.
27. What is the customer lifetime value (CLV) and customer acquisition cost (CAC)?
The owner should provide reasonable estimates of CLV and CAC, showing how much a customer is worth over time and how much it costs to acquire each new customer.
If CLV is much lower than CAC, or if the business has an inefficient customer acquisition strategy, it could indicate problems with profitability and sustainable growth.
Final Thoughts
Asking the right questions and thoroughly reviewing the responses will give you a clearer picture of the business's true value and potential risks. Focus on transparency and clarity from the owner to help you identify red flags that may affect your acquisition decision. If something feels off, don’t hesitate to ask for more details or seek expert advice to avoid costly mistakes.
Navigating the business acquisition process alone can be complex. That’s why our team of experts is here to guide you every step of the way. With our acquisition program, we handle all the negotiations, due diligence, and post-acquisition scaling for value enhancement to position your business for a 3-10x multiple exit.
Book a free consultation call today to learn how we can help you succeed.
