Business options: Buying the assets of an existing operation
Considerations include depreciation of real estate, existing equipment and anticipated inventory turnaround.
Purchasing a business from the current owner offers many of the features needed for success, including an existing location and customer base. In part 1 of this two-part series by Michigan State University Extension discussed the reasons to buy an existing business and factors in negotiating a purchase price.
Another aspect when purchasing an existing operation is buying existing assets. The book value of fixed assets is open to discussion. Real estate (buildings not land) might have a depreciated book value that is not consistent with the market value. Land, while not depreciable, can be represented by a book value somewhat less than the market value. Fixtures, machinery, equipment and leasehold improvements, have value and should be included in the tally. Current assets, those convertible to cash within one year, also warrant close inspection.
Product inventory should be valued at the current replacement value or a blending with the purchase price. Inventory turnover rates (how many times per year the inventory sells during a year) will provide a picture of the vitality of the inventory mix. Comparison with similar business benchmarks will assist with this process. Physical counts and having in place a buy-sell agreement as to the expected inventory levels at the time of transfer will help to eliminate conflict regarding “where and what.”
Other current assets that might be part of the purchase agreement and add value to the selling price is accounts receivable. While the use of credit cards has allowed some businesses to reduce accounts receivables, many still carry this asset on their books. A quick comparison between the average carried and the yearly credit sales will glean a turnover rate for the receivables also. If the credit terms are 30 days, the turnover rate should be at least 12 times per year. Any number less than this would indicate a need to age the receivables to determine their true value (and collectability).
Adding up the assets together with the expected return on investment (allowing for invested labor) will provide a starting point for negotiations on a purchase price and terms of payment.