Suppose you are thinking about buying a small business. What do you care about; what is important to you?
Ultimately, the most important factor is anticipated future earnings of the business – what returns the business will produce in the future on your investment of capital and your investment in labor. If you buy a business, you do so believing that future cash flows and profits produced in the future will justify the purchase price and the on-going investment of labor.
What are some of the factors that impact future earnings? Many of the factors are specific to the particular business, but some future trends apply to almost every small business:
Interest rates – lower rates mean lower payments on your loan which means higher profits.
Commodity prices – lower input costs mean lower cost of goods sold which means higher profits.
Unemployment rates – higher rates of unemployment make finding the right employees a little easier and the right employees can lead to higher profits.
Real estate prices – lower real estate prices usually mean rents are lower which means higher profits.
Of course, trends in the opposite direction can lead to lower profits!
The keywords here are “anticipated” and “future”. While past performance can be a starting point to evaluate a business, what the former owner was able to do isn’t too important to a new owner. What is vitally important is what the new owner can do with the business.
As an example, say you are considering a small manufacturing business that made $100,000 each year for the last 2 years. Looking closer, you discover that one large customer accounted for 50% of that profit. If that one customer is lost, there is only half the profit! Looking at what happens if that customer is lost means you are focusing on what matters: anticipated profits.
When considering the purchase of a business, a buyer needs to analyze him/her self as much as the past performance of the business and ask what he/she can bring to the business either to ensure stability of the business or more importantly, what skills the new owner can bring to make the business better.