View Full Version : How to detemine the financial health of a business

12-09-2010, 03:02 PM
I'm good at what I do professional, but when it comes to finances I'm like a deer looking at headlights. So I was hoping to get some help from you all.

I'm becoming a partner and looking to make a capital investment to this business. My future partner has had this business for 4 years now and his wife is in charge of all the financial stuff. I'm sitting down with them next week to look over all the finances and determine how much to contribute and get an idea of the finances. What are some basic questions to ask to determine the overall health of the company? what are financial signs a business is struggling?


12-09-2010, 04:28 PM
Everything depends on the nature of the business. Unfortunately, there is no one-size fits all answer to your questions. It'd be similar to going to the super market and saying "I'm looking to purchase some groceries, but I don't know how long the groceries will be good for. Do you have any idea?" Well, it depends on whether you're talking about a canned good, milk, eggs, vegetables, lunch meat, bread, or whatever -- there is no uniform answer.

Some general things, with any business, especially a service one like you're about to become part of:

1. How many clients do you serve? What percentage of your revenues, roughly, come from these clients? If there are 20 clients and you have one that say comprises 50% of the revenue, you may wonder what may happen if that client no longer wants your services and how the company will manage. There could also be a reason the other 19 clients aren't as large too, so you need to figure out why.

2. What are gross billings? (Meaning, how much $$$ do they bill out each year. This should be on the income statement. Also, figure out approximately how many hours they work, you can do the math backwards to get an average hourly rate.)

3. How often do you bill? How long does it take to collect? Have there been any recent collection issues with clients?

4. Does the business have any debt? How much? What is the plan to pay it off? (You may also want to see, if this is on the balance sheet, whether this looks extraordinarily high.)

5. Does the business own any property? What kind?

6. I'd look at the balance sheet to see what they list as assets... Is it all funds just sitting in a checking account? Do they have a savings account, or do they just sit unnecessarily on large sums of non-interest bearing cash.

7. I'd look at the income statement to see which expenses they have, and whether any seem particularly high in relation to other expenses. Figure out what exactly it is for.

I mean, there are a billion things to look at, and each industry is different. You really should meet with a CPA to review the numbers and see whether they make sense. I'm also interested (though they probably aren't) in whether the financial statements are compiled by a CPA, or just printed off of QuickBooks/Peachtree.

If you're making an investment decision based on unaudited or unreviewed financials, who knows what the result is going to be. I mean, I could very easily print you off some very nice looking financials that you'd go "of course I have to buy into this company", but unless there is any substance behind the transactions and they were prepared by a CPA, I wouldn't bet my life on it.