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Getting at the truth
As the saying goes: the devil is in the details -- and there's never been a truer word spoken!
The problem, of course, is that financial statements only make sense if you understand them, which also perhaps means that you have to have been involved in owning/running the property yourself to realize why they are what they are -- and never mind what they ought to be!
Undoubtedly, a financial audit does no harm. Indeed, it's all but de rigueur. However, the best measure of a property lies in what's called Management Accounting, which differs in principle from what a set of books is designed to show. It pays scant attention to an historically oriented formula: Actual Revenue less Actual Expenses = Actual Profit. Instead, its foundation lies in a system of budgetary control, which translates into: Required Profit = Anticipated Revenue less Allowable Expenses.
This is, of course, the basis of a Business Plan -- or certainly ought to be -- and is quite likely not going to match the one that the existing owner has used in achieving the results you're shown!
The details of a due diligence exercise
Coming in from the outside, you need to question just about everything. As already mentioned, recorded sales, expense, and profit/loss figures provide no more than an historical snapshot of the results. This isn't to call them incorrect (although Enron and other recent fiascos can justify doubts about their accuracy!), but, at the least, they don't necessarily resemble what they'll be under your (new) management. Similarly, the assets and liabilities have underlying meanings that may not continue if you take them over.
One of the numerous outlines of due diligence can be found at http://www.diomo.com/-due and, for the asking price of $24.95, it's probably money very well spent. It's a downloadable package designed to help you take a completely jaundiced view of what's for sale, stripped of all the hype that the seller (albeit understandably and perhaps not altogether unjustifiably) uses to describe it.
By no coincidence, too, -- although the idea is seldom reported as being related to it -- the key that the (sometimes unduly degrogatorily called) hatchet men and turnaround artists bring to the challenge of transforming a losing business is an extremely skeptical view of everything that exists.
All told, the goal once more is to come up with answers to a couple of all-encompassing questions:
Do I know enough about what I'm planning to buy?
Is it at least as much as the seller does -- and preferably more?
Searching the Web
Apart from the diomo site I've mentioned, the introductory page at http://www.investigation.com/due_diligence.htm and those that follow it offer an excellent look at how you can reduce the risk that an acquisition is going to result in some unrecognized surprises.
Any questions? Something not clear? Need more information?
Please feel free to contact me:
Phone: (905) 468-3154 / Cellular: (905) 704-9037
e-mail: ebb@iciniagara.com
Or use the feedback form on the Contact Me page.
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