Is 2025 the year for adding to your investment portfolio? If so, then you’re probably keen to learn how to size up your acquisition targets and sort the wheat from the proverbial chaff.
One of the most crucial aspects of your target to assess is, of course, their financial health. After all, unless you have limitless financial reserves, you don’t want to find yourself taking on the business equivalent of a sinking ship. But how do you effectively evaluate a company’s financial well-being before purchasing it?
To help you make the right choice, we’ve prepared an insider’s guide to assessing a target’s finances, including key ratios to measure to give you a nuanced picture of the company’s monetary health.
With this essential knowledge, you should be able to go forth with confidence and carefully evaluate your prospect’s suitability before signing on the dotted line.
The ratios you need to know
First things first, let’s explore some of those crucial ratios you need to be familiar with when it comes to assessing a company’s finances. While these ratios should not be used on their own to decide your target’s suitability, they can help give a clearer picture of its health and prospects.
The ratios are as follows:
- Debt-to-equity ratio
- Current ratio
- Net margin
As the name suggests, the debt-to-equity ratio measures a company’s debt against its shareholders’ equity. Unsurprisingly, a lower ratio is favourable as it means that more of the company’s funding comes from its shareholders as opposed to its creditors.
The current ratio is a measurement of a company’s capacity to pay off current debts using its current assets. In other words, this ratio demonstrates the business’s ability to meet its financial obligations for the fiscal year. Because current ratios vary from industry to industry, it’s a good idea to compare your target’s ratio to the industry average; if it’s in line with that average then this is a good sign, although if it’s just a little higher that shouldn’t be cause for concern.
Finally, the net margin ratio can be used to measure your target’s profitability, as it gives you the ratio of net profits to total revenue. This is a particularly important metric, as a larger net margin ratio indicates a company in a stronger financial position.
Weighing up profits and loss
As we’ve already mentioned, using the ratios on their own isn’t enough to build up a detailed picture of a target’s monetary health. There are several crucial financial documents you will also need to analyse with care, and among these are your target’s profit and loss statements.
Examining these charts of revenue and expenses can give you a nuanced picture of how the company has been faring and how efficiently it has been operating over the past few years.
In short, the profit and loss statements will help to reveal both its strong points and its weaknesses.
Consider the cash flow
Similarly, while you’re poring over profits and loss, you should also carefully examine the company’s cash flow statement to work out where money is coming in from and where it’s going out to.
The cash flow statement is another important indicator of a company’s operational efficiency – or lack thereof – which is why it needs to be included in your financial scrutiny. Not only that, but it can also give you fascinating insights into how a business’s cash flow may alter according to seasonal trends, which is very valuable knowledge, especially if you don’t have a lot of experience in that market already.
EBITDA explained
Also known more clunkily as Earnings Before Interest, Taxes, Depreciation and Amortisation, the EBITDA is another financial metric to scrutinise before committing to buying a business.
EBITDA reveals a company’s core profitability and helps you get a sense of the company’s current financial position and future potential. You can also use this figure to compare it to its competitors and to generate an accurate valuation for the business.
The importance of the balance sheet
To gain a detailed picture of what a company owns and how financially stable it is, you should carefully examine the balance sheet.
Balance sheets record a business’s assets (fixed, tangible and current), as well as its stocks, its creditors, its liabilities, capital and reserves and shareholders’ funds, among other crucial information.
By weighing up the figures on the balance sheet, you should be able to get a clear picture about whether your target is struggling with debts or if it is on a relatively firm financial footing. However, it’s worth bearing in mind that, even if a company is in what is termed a ‘net debt position’, this does not necessarily mean it is a lost cause, as external circumstances beyond its control could have pushed it into this position – such as a global pandemic, for instance.
How a business broker can help
Choosing the right business to buy may seem like a tall order, especially with so many vital metrics to measure and so many financial documents to pore over.
Fortunately, there is a way to make the whole acquisition process simpler and much less stressful – hire a business broker to take on the complex tasks on your behalf!
Having a tried-and-trusted business broker on your side will automatically streamline the M&A process from start to finish. A business broker can help you source and verify potential targets and provide expert valuations to give you an accurate insight into what they are really worth.
What’s more, a business broker can assist with negotiations and due diligence, answering those tough questions about a target’s true financial health – or lack thereof – so you can make an informed decision about whether to proceed with the acquisition.
Finally, a business broker worth their salt can provide nuanced insider tips and advice on how to make an acquisition work, such as how to manage integration successfully and maximise the value of your new company.
Harris Acquire – for a hassle-free acquisition
Here at Harris Acquire, we pride ourselves on making the complex and possibly intimidating acquisition journey a pleasant and straightforward one for both buyers and sellers.
Our friendly and experienced team understands how life-changing an acquisition can be. As a result, we work tirelessly to oversee every stage of the process, removing the stress from the transaction so you are free to focus on the end result and plan your next chapter.
From making that initial contact, to mediating negotiations and optimising the due diligence process we will be there every step of the way to help you get that all-important deal over the line.
What’s more, we’re currently offering an exclusive Acquisition Finder service which comes with a 30-day money-back guarantee for your peace of mind, making this the perfect time to buy a business!
To find out more about our services and get the M&A ball rolling, give us a call on 01926 757100 or send a query to Hello@harrisacquire.com.
