Anyone involved in operating a business should have at least a working knowledge of the key business terms relevant to that business. But when you are a would-be entrepreneur looking for a business to buy, understanding such information becomes absolutely crucial if you wish to assess the health and prospects of any existing business for sale.
So, here’s a list of some important business terms any business buyer will be likely to encounter, and must be able to grasp, when searching businesses for sale.
Often mentioned in business discussions, cash flow is simply the net total of cash and/or cash-equivalents passing into and out of any business. At a basic level, the ability of any business to create value is really determined by its ability to continuously generate positive cash flows.
Therefore, a healthy cash flow has positive implications for the liquidity, flexibility and overall financial performance of a business for sale. For example, a positive cash flow suggests a company’s assets are increasing, which in turn gives the company the headroom to make positive investments when required.
Net profit will most certainly interest a potential buyer and is defined as what monies remain after all business costs have been taken from the company’s sales revenue. So, a business with sales of £200,000 and costs of £150,000 will have accrued a net profit of £50,000. Put another way, for every pound the business has collected in sales, 25% of that figure has then been converted into a business profit.
It can also be said that the company’s profit margin is running at 25%. This figure would reassure a would-be buyer that the business has been well run because it has kept its operating costs fairly low. This net profit information becomes even more useful if year-on-year, and even month-to-month, data is available. That kind of information will reveal peaks and troughs in company performance which a seller could then be asked to describe and explain.
A non-disclosure agreement (NDA) is a legally enforceable document which buyers may often encounter during a business sale negotiation. If preliminary sale discussions have gone well, both buyer and seller will wish to make further progress. At this stage, the buyer’s due diligence team will want to examine the business records to report on the health of the business as well as to verify the seller’s estimate of the value of the business.
For the seller, this entails revealing commercially sensitive information to outsiders, which is why the buyer (and sometimes the seller too) is often asked to sign a non-disclosure agreement. An NDA is likely to incorporate harsh penalties to dissuade anyone from releasing confidential business information into the public domain.
Revenue is the total income which a company generates from its normal business operations involving sales of goods or services.
So, this calculation includes such elements as customer discounts and also any deductions for returned merchandise. Thus, revenue is a gross income figure from which all business costs and expenses are then subtracted.
It’s important for any buyer to realise that revenue is considered the ‘top line’ on any company accounts or balance sheet, whereas the ‘bottom line’ consists of the company’s net income after all costs have been deducted – in other words the business profit.
So, while an impressive revenue figure may suggest the company has been involved in lots of trading, that information alone says nothing about the efficiency of the business, or even whether it actually made a profit.
A balance sheet, often referred to as the ‘company accounts’ can often look quite complex to a buyer unfamiliar with such documents. But the balance sheet is really a financial statement which offers a ‘snapshot’ of the company’s finances on the date it is published. The balance sheet reports on what the business owns, what the business owes, and also discloses any investments made by shareholders. Like other financial documents, a balance sheet can only reveal trends and company growth when one sheet is compared with others over a period of years.
Becoming familiar with these and other key business terms will enable you to assess a variety of different factors and thus help you identify a good business to buy. And of course, it will also warn you about any businesses you really ought to avoid.
By Matthew Hernon an Account Manager at BusinessesForSale.com looking after Business Transfer Agents and Franchises across FranchiseSales.com.