Confirm Sales before Buying

by Mike Hindle of Aldes Business Brokers

Turnover, or sales, is the second biggest problem area for the buyer to overcome. Not only must he be able to verify that the business is doing the turnover claimed, but that it will continue to after the seller has left. Most other sections of the financial side of the business you will be able to clarify, but it is the element of cash sales which starts in the turnover that causes the headaches.

In a recent newspaper article, someone estimated that the country is losing R450m in VAT. I doubt if that's even the tip of the iceberg. If all, or a large part, of the sales are on account then all you need do is obtain a list of the clients and start checking them out. The real problem is with the cash sales. How are you going to confirm them? Ideally, you would stand next to the till for a couple of weeks and virtually count the money as it comes in. But who has the time? You could check the seller's bank accounts for the last year to see how much cash was deposited, but it's unlikely this will show all his takings. Then you would look at his purchases over the year to see if , based on claimed markup and gross profit, turnover is borne out.

A wise buyer will have his accountant help him recreate an income statement on the business from these investigations. But that's still not foolproof. As the buyer you are going to have to make a decision on the evidence at hand. If your advisor can verify at least 80% of the turnover, then there is a good chance that the balance is true.

Having established that the sales are there you must now examine the following aspects:

* VAT. First find out whether turnover is inclusive or exclusive of VAT. Often a seller is inclined to forget to take off the 14% VAT, which has the effect of inflating profitability.
* Monthly turnover. Obtain the monthly turnover for the last two years. This will show if there is a steady increase in sales over and above pure price increases. You may not want to get involved in a stagnating or declining business. You will also be able to tell whether sales are affected by seasonal patterns, which could greatly effect your cash flow. This is particularly dangerous with businesses in holiday areas where turnover fluctuates enormously.
* Breakdown of turnover per product. Calculate sales of food, sweets, cold drinks and cigarettes. This helps ascertain whether effort and shop space are proportionate to the turnover. Later we will also check if it is contributing to the biggest profit.
* How is turnover achieved? It may be from over the counter sales, from the representatives calling, or from advertising. Is the business spending its money on areas that are producing the sales and are other sections exploited enough?
* Client spread. If you rely on passing trade, no problem. But ideally one wants a breakdown of clients and how much each contributes to turnover. If most sales are to only a few clients, you want to be able to check them out. We were asked to sell a very profitable little business allied to the motor trade as the seller wanted to retire. The business had been established for 12 years and for many years one large motor group had given them more than 60% of their income. The seller said there were no problems and the turnover would continue to come in as it had done in the past. He neglected to mention that this large client had decided to do all the work themselves and not send it out anymore. If this has not been discovered, an unsuspecting buyer would find profits going down the tubes as 60% of the turnover walked out the door.
* Stable clients. Depending on how important they are to the business, you may want to make some inquiries as to how solid their businesses are.

Mike Hindle of Aldes Business Brokers, www.aldes.co.za

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