How to evaluate a business before you buy

Most acquisition discussions begin with a number. The seller has an expectation, the buyer has a budget, and both parties negotiate around a figure that has not yet been tested. It is more productive to establish what the business actually earns on a maintainable basis, and then to apply a multiple that reflects the risk attached to those earnings.

Maintainable earnings means the profit the business would generate for a new owner, after removing costs that will not continue and adding back costs that will. The work is not complicated, but it is unforgiving: every adjustment needs a document behind it, and any adjustment that appears in each of the years presented should be treated as an ordinary cost.

Reported profit is an accounting outcome. Cash is what services debt, funds working capital and pays the owner. Where operating cash flow sits materially below reported profit over a sustained period, either the profit is not real, or the working capital requirement is larger than the accounts suggest.

The explanation matters as much as the gap. Timing differences between years are normal. A structural difference that persists across three years is a question about earnings quality.

Customer concentration is the single most common reason that SME earnings prove less durable after completion than they appeared beforehand. A business with a large share of revenue in a handful of relationships is not necessarily a poor business, but the buyer needs to know what happens to the cost base if one of those relationships ends.

The analysis belongs at customer level and at margin level. A large account that contributes little margin can still absorb the capacity that the rest of the business depends on.

In most owner-managed businesses, the owner is doing three jobs: running the operation, holding key relationships, and making the decisions nobody else is equipped to make. On completion, all three have to go somewhere.

Reconstructing the owner's working week is a practical way to size the problem. Diary records, client correspondence and delivery hours usually show more personal dependency than the organisation chart suggests.

Price, payment mechanics, deferred consideration and warranties are where a well-analysed deal is protected or exposed. A structure that ties part of the consideration to the assumptions being correct is often worth more than a reduction in the headline price.

Finally, consider the process itself. Time for validation, access to information and exclusivity determine whether the analysis you have started can be completed before the terms are fixed.