Below are 5 key financial factors to be aware of when studying a business’s financial model and future growth.
1) Net income – There are multiple net income ratios to study at when deciphering a business’s bottom line. For example, the ratio of gross profit over net sales allows the owner to determine the business’s profit margins compared to similar companies. The ratio of net income over net worth shows the owner whether or not the company will earn a reasonable return on their product. Last, the ratio of net income over total assets tells an owner whether or not the company is obtaining a favorable rate of return on their assets.
2) Sales – Sales numbers can appear better than they really are. When thinking about purchasing a business, make sure to read between the lines when studying the growth in sales and earnings. It is important to distinguish whether the growth rate is because of higher prices or an increased sales volume. It is also important to be aware of the marketplace. A market can be static, so there is little potential for growth.
3) Operating environment – The way in which the business environment operates and its corporate culture is critical to studying long-term growth. If a company mostly deals with international clients, it is important to research the long-term political environment of the countries in question. It is important to look at economic and consumer trends to make sure that the product will still be popular 10 years from now. Can your product keep customers for life, or is this just a one and done product?
4) Fixed assets – Fixed assets are assets that are tangible and cannot be easily converted into cash; such as property, plant, and equipment. If a company has excessive fixed assets, it is important to understand why. If equipment goes unused, this can be a sign that demand is declining or that the owner miscalculated manufacturing needs.