Analysing Businesses for Dummies
It’s very tricky trying to do this when you don’t have any real business acumen or experience. I do have both but I still find it difficult at times to really evaluate a business and determine whether it’s a good investment, bad, or break even.
Here are the things I look for first.
- Type of model
- Percentage cost of sales to income
- Percentage overheads to income
- Wages percentage of income
- Growth potential
Let’s look at each one a little more
1. Type of Model
By model I mean it is a free standing independent business or a franchise. If it’s a franchise it’s an immediate pass for me. I’ve analysed most of the ‘top’ or popular franchises and the bottom line is you are buying yourself a mid level income and working your butt off for it. There is no real way to expand on your income because you lose the exact same amount that you increased in percentages back to the franchisor.
The only model I look at now is either an independently owned chain, or an independent business that has the potential to be replicated at another location.
The business should not be in a shopping centre if this can be avoided. The rents are exorbitant compared to other areas and the shopping centres have reacted way too slowly to the online trend, cramming their centres with eateries and entertainment to get people through the door. Break even point is difficult to get and again, you are just buying yourself a wage and at the mercy of the shopping centre management in terms of rent increases and percentage of sales. It’s basically a massive franchise.
2. Percentage Cost of Sales to Income
Cost of sales is the amount of money it takes to get the products/services/materials to make the stuff that you sell. In my view the percentage should not be more than 25% of income. When I’ve analysed businesses, anything over this has revealed a very low profit at the bottom line. There is room to wiggle this percentage if the overheads are below 30%.
3. Percentage Overheads to Income
As eluded to above, this figure should also be as far below 30% of income as possible. Wages will tend to make up at least 50% of the overheads. If there is no indicative wages cost in the profit and loss statement, extra scrutiny of the business is required. Either it is a sole trader, or they are not paying wages officially (or correctly within the law).
4. Wages percentage of income
Wages should come in at about 25% of total income, and as above more likely to come in at 50% of overhead costs. Any variation to this indicator needs careful scrutiny.
5. Growth Potential
Questions to ask after all these figures stack up favourably, is can I grow this business? Can I increase sales? Decrease costs? Open another location and actually double the current income? What is my competition? How can I stand out? What is not being offered to the market? What is being offered to the market? Are the price points correct?
Conclusion
There are probably a hundred other questions, but these are always my mainstays when i first look at a business. Recently I reviewed a business that ticked all the boxes and there was a healthy $80K left over as the bottom line. I made an offer the same day after inspecting the premises. Something wasn’t quite right though. When I looked through the figures again there had been no allowance for wages even though the owner had talked about employees. Once wages were factored in, it was a loss with no room to expand exponentially and so got a no from me.
Profit and Loss statements can be a very scary and confusing document to analyse. When viewed on the basis of a percentage of income, the guidelines a little clearer and more able to be given a positive or negative outlook from the beginning.
Happy analysiing.
