There are certain terms that you should know if you are buying a business. It is, however, important to know that you don’t have to know everything. You just need to know who to contact for help and advice.
It is good to select an accountant and an attorney to help you when needed. The business you are purchasing will likely have accounting software which you may want to continue to use. You will decide to use the accrual basis of accounting or the cash basis. If your business uses the accrual basis, revenues are credited to the period earned and related expenses are charged to the period in which they are incurred regardless of when cash is received and disbursed. If the cash basis is chosen, revenues are recognized when cash is received, and expenses are recorded when they are paid.
The Income Statement (Profit and Loss Statement) is a summary of the condition of a business over a time period. It shows the income minus the expenses, which equals the net profit or loss. These are prepared monthly to show how the business performed each month of the fiscal year, providing information to plan for slower months. When looking at Income Statements of a business you are considering purchasing, you will be able to see if each month is similar or if you need to plan your budget around the slower months. An Income Statement is always prepared for the twelve months of the fiscal year, which is not always the calendar year. Your accountant will help you with that. Unlike the Income Statement that is for a period of time, the Balance Sheet is for a specific date. It is a listing of assets, liabilities and net worth of a business and is a statement of condition. It is always prepared for the last day of the fiscal year but can also be done on any date. A fundamental characteristic of every balance sheet is assets equal liabilities plus owners’ equity.
Depreciation is a systematic reduction of a fixed or capital asset to reflect the decline in value through wear, tear and obsolescence. Fixed assets are listed at the purchase price and are set up on a depreciation schedule, showing the value on the books to be less each year until they are completely depreciated. Most businesses sold are asset rather than stock sales, which means you can list the assets at market value (their worth currently) and start a new depreciation schedule when you purchase the business. Depreciation is not a real expense. It is strictly a legal tax advantage. If you are getting a loan to purchase the business, you will list the assets as collateral at their current market value and not the book value, as the market value shows their true worth. A large percentage of business purchases are financed by the sellers of the businesses. Some advantages of seller financing include lower interest and down payment, collateralized by the business, and longer term.
When an offer is made to purchase a business, it must include earnest money, which is a substantial deposit to indicate sincerity (usually 2% to 5% of the offering price). This will be returned if an agreement is not reached or if anything is different than presented. Several conditions throughout the offer must also be met.
A Covenant Not To Compete is important. For the purchaser, this is a direct expense to write off. To the seller it becomes ordinary income over the fixed life. In order for a covenant not to compete to be binding as well as a write off for the purchaser, it must possess three elements: Time, Distance, and Consideration (Dollar Value). You do not want the experienced seller to go across the street and start a competing business, drawing your customers to his business. You may think it won’t happen, but it sometimes does. Everything must be in writing.
A training and consulting period will be included in the offer to purchase. Unless a business has a complicated learning curve, a couple of weeks is usually long enough for the seller to work in the business with the purchaser to assure he/she is familiar with the daily routines, vendors, employees and customers. In addition, it usually includes a couple of months or more to allow the purchaser to call the seller with questions. It makes for a smooth transition and there is no charge to the purchaser.
Select a good business attorney, accountant and business broker. Remember, you don’t have to know everything; you just need to know who to ask!
