A company can have strong historical earnings and still present significant operating risk. Customer concentration is a good example. Suppose a business reports $4 million in annual revenue and $800,000 in normalized earnings. On the surface, the numbers may look attractive. Then we discover that one customer represents 42% of revenue. That changes the analysis. … Continue reading Customer Concentration: When One Customer Is Really the Business

A seller provides a schedule showing $325,000 of add-backs. That does not automatically mean normalized earnings are $325,000 higher. An add-back schedule is a starting point, not a conclusion. Each material adjustment should be tested. Was the expense actually recorded? Can it be traced to the financial statements or general ledger? Is there documentation? Is … Continue reading Unsupported Add-Backs: A Schedule Is Not Evidence

Privately held businesses frequently run personal or discretionary expenses through the company: automobiles, travel, meals, cell phones, insurance, family payroll, club memberships, and entertainment. Sometimes those expenses represent legitimate add-backs. But the analysis cannot stop at “the seller says it is personal.” The real questions are these: Was the expense actually incurred? Is it included … Continue reading Personal Expenses: Real Add-Back or Recurring Business Cost?

A company can look very different depending on how its financial statements are prepared. Cash basis, accrual basis, tax basis, internally prepared statements, CPA-prepared statements—each may tell a slightly different story. That is why financial reconciliation matters. A growing company may report strong cash-basis earnings simply because payables increased. An accrual-basis company may report revenue … Continue reading Cash vs. Accrual: Same Business, Different Story

Sometimes high earnings are high because the business has postponed spending money—on equipment replacement, fleet maintenance, computer systems, facility repairs, tooling, furniture, or production machinery. A seller approaching retirement may minimize capital spending for several years. That can improve historical cash flow, but only temporarily. The buyer may inherit the bill. Suppose a company reports … Continue reading Deferred Maintenance and CapEx: Earnings Can Be Too Good

Privately held businesses are not always contained neatly within one legal entity. The operating company may lease property from another entity owned by the seller. Employees may be shared. Administrative expenses may be paid by an affiliated company. Vehicles may be owned personally. Intellectual property may sit elsewhere. Purchases may flow through a related entity, … Continue reading Related Entities: Make Sure You Are Analyzing the Whole Economic Picture

Sometimes the biggest risk in an acquisition does not appear on the balance sheet or income statement. It walks out the door after closing. Consider a business where the owner is responsible for 60% of sales, the major customer relationships, pricing, estimating, vendor negotiations, technical expertise, employee management, and quality control. The company may have … Continue reading Earnings Dependent on People Who Are Leaving

This may be one of the most important questions in acquisition due diligence: is the buyer actually acquiring the assets necessary to generate the historical earnings? Those assets may be physical—equipment, vehicles, inventory, specialized tools, animals, licenses, technology. They may also be intangible—contracts, customer relationships, trade names, software rights, permits, intellectual property, exclusive supplier arrangements. … Continue reading When the Assets That Generate the Revenue Are Not Transferring