Dear Dave,
I have an opportunity to buy a small business. What should I look for and what things should I check on before I make my decision?
Al
Dear Al,
The first thing you have to be absolutely certain of is that you’re going to wake up every morning and be excited you get to go to work again. Business owners must be passionate about their line of work because they’re going to be involved in each aspect of it every single day. Your vocation needs to be a vacation. Otherwise, it becomes a constant grind, and when that happens you’re in trouble.
As far as buying a business is concerned, you’ll want to take your time and really dig into things. In many ways, a business is only worth the income it creates, and just because it has a great location doesn’t mean you’ll make money. Who cares if they have a great name in the community if the business doesn’t generate an income? The same thing goes for having a brand everyone knows. If they’re not monetizing it, who cares? It all comes down to the net profit of the business.
Sometimes people buy businesses on multiples of gross sales before expenses. You may know enough about that particular business to understand that you run it for a certain number of percentage points of the gross. In that case, you’ll know what your profit will be. But most of the time when buying a small business, especially if you’re a rookie, you need to concentrate on gross revenue, expense details and the profit generated as a result.
Once you’ve done that, you’ll want to ask what you will make on your money. If you’re going to take on the risk of a small business, you want to be able to make at least 20 percent on it. In other words, if you buy a business for $100,000, it needs to make at least $20,000 a year.
The least it’s worth is called book value. Once you own the business, if you collected all the receivables, sold off all the equipment and inventory then closed the business, what would you have in your pocket? That’s the book value. If the current owner has $40,000 in inventory, $30,000 worth of equipment and $30,000 in receivables, the book value would be $100,000 just if you close it. Those are your floor and ceiling values. Somewhere in between you’ll find a fair price.
And remember this: If someone says a business does $65,000 a year, but they only pay taxes on $40,000, that means all they made was $40,000. If they don’t report it to the government, it doesn’t count. Don’t pull that under-the-table kind of stuff. A business is worth what is reported to the government, so take a good, hard look at the tax returns.
Lastly, do some research and find out ifthere’s someone in the same business, inanother city, who would mentor you for a while.It just might be worth the price of a plane ticketto pick their brain and just listen to what theyhave to say. Chances are if they’ve been inbusiness for a while, they know the ins andouts of the industry.
Good luck, Al!
—Dave
Dear Dave,
I have a small business doing work on houses. We have lots of repeat business, but sometimes people don’t pay and we have to drop them as customers. Do you have any advice for avoiding these situations?
Steve
Dear Steve,
Virtually every small-business owner runs into this problem. The truth is collecting isn’t a customer problem; it’s a sales problem on the part of the business.
When we sell advertising for my radio show then have trouble collecting, it means we sold the account improperly. Now, what is a properly sold account? A properly sold account is one in which we approached a qualified customer who had money, and the relationship was constructed in such a way that they realized from the beginning paying us on time was an – important—even vital—part of the relationship. When we sit down with potential advertisers, we make it clear that we will bill them exactly on the 25th of the month. We also stress that we expect to be paid within five days. If we don’t have payment by the first of the next month, they’ll be getting a phone call. Then, if they don’t respond to the call by the 15th, they won’t advertise with us ever again.
That may sound harsh, but I believe a thorough understanding is essential in all business transactions. It keeps things professional and eliminates a lot of unnecessary stress for you, your team and your bottom line!
—Dave
Dear Dave,
I have a 140-acre farm, and I recently began running my operation debt free. The problem is that I have $250,000 in debt hanging on from bad decisions in the past, and the varying expenses in my business make it difficult to budget. Do you have any suggestions for budgeting in a volatile industry like mine?
Tyler
Dear Tyler,
Obviously, you want to set up a separate budget and run a profit and loss statement. You’ll want to estimate the income, as best you can, for the year, and you’d need to estimate your expenses item by item and category by category for the year. Then, you’ll want to break that down by month. This is called laying out a business pro forma. In other words, a business budget.
Next, you’ve got two goals to work toward with your profits. By profits, I mean after you’ve paid household expenses. That includes a living wage, enough to operate, keeping food on the table, the lights on and that sort of thing. After basic living expenses are out of the way, your net profit in the business should be divided between retained earnings—which is savings—and debt reduction. The idea here is that you’re going to put the lion’s share toward paying off debt. Still, you need to have something set aside for a rainy day. In your case, that could be taken literally.
Keep in mind that in business, retained earnings are used for more than just emergencies. They’re also for buying equipment, more land and anything else that will grow your operation. But you always want a pad in there for that and other reasons. What if you have a strange year, and your budget estimates were way off? It could be unexpected expenditures or the fact that you simply had a bad year. In business, that’s called an emergency, and you’d take that out of retained earnings.
Doing a budget, whether it’s in personal finance or a business, is something that gets easier and more accurate with time. You won’t get everything right the first couple of tries, but over time your estimates and budgeting skills will become more accurate because they’ll be based on experience.
Good luck, Tyler!
—Dave
Dear Dave,
I own a small business, and I’m having trouble scaling up while keeping expenses down. Do you have any advice for me?
Josh
Dear Josh,
There are two types of expenses: fixed and variable. Variable expenses rise as the volume and size of your business grows. A good example of this would be shipping. The more stuff you move, the higher your shipping bill. Fixed expenses are there regardless of your income. Rent is a fixed expense. The amount doesn’t change, and you have to pay it whether you’re making money or not.
The best advice I can give you in a scenario like this is to take a deep breath, and accept the fact that you need to slow down and grow slowly and steadily. If you let expenses get out of hand, you’ll be chasing them and playing catch up for the life of your business. Overhead kills businesses, Josh. It’s the death knell.
—Dave
