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Helpful Financial Ratios for Business Sellers

As a business owner you should be preparing an exit plan that should include an analysis of the performance of your business. Every business owner wants to exit the sale of his company with as much proceeds as possible and that starts by maximizing the value. Maximizing business value is dependent on increasing profitability at least two years prior to taking the business to market. One helpful analysis is to perform some simple balance sheet ratio calculations. Your business broker / advisor can assist with this process. I share a few below:

A/R Turnover – Is used to determine your effectiveness of collecting your A/R. Generally, a higher number indicates a healthy cycle and quality customers that pay on time. Receivable Turnover = Revenue / Average Accounts Receivable

Current Ratio – Is used to determine your ability to repay short term liabilities. Generally, if the ratio is below 1 it is a warning sign. Current Ratio = Current Assets / Current Liabilities

Quick Ratio – Is used to determine your ability to repay short term liabilities with your most liquid assets. Generally, the higher the ratio the better & anything over “1” is considered healthy. (Current Assets-Inventory) / Current Liabilities

Debt to Equity – Is used to determine how you have been financing growth. Generally, the higher the number means the company has been using debt to grow. You may want to determine if the return from borrowing is greater than the cost of the debt. Debt to Equity = Total Liabilities / Shareholder’s Equity

Days Sales Outstanding – Is used to determine how well you convert A/R to cash. Generally, a higher number may indicate that you are selling on credit which can take more time to convert to cash. DSO = (AR / Revenue) x 365

Inventory Turnover – Is used to determine how quickly your inventory is moving. Cash is king and inventory is like cash on the shelf. The result can be very industry specific. Inventory Turnover = COGS / Average Inventory Value

Call on your accountant or CPA and ask them for “peer group” data to compare your results to your industry. This analysis may provide you with some opportunities to develop a plan to increase profitability and as a result maximize the value of the future sale of your business. Understand that your ratios may vary significantly from other industries so be careful when attempting to make a judgement call on how your company is performing against its peers.

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