As a business owner who is contemplating selling his business you should be preparing an exit plan that should include an analysis of 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. I share a few below:
1.) 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
2.) 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.
(Current Assets-Inventory) / Current Liabilities
3.) Total 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
4.) 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
5.) 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
6.) 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
Ask your CPA or accountant for some peer group data to compare your results to your peer group. This analysis may provide you with some real opportunities to quickly increase profitability and as a result maximize the value of the future sale of your business.
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