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Verifying the Information You Have Been Given

Written by: Timur Sultanov

Article Overview: Although you will have been supplied with copies of accounts, it is vital to check that the trading information you have been given is fully truthful. At the early stages of your discussions with the vendor you clearly have to take the figures at face value, but before you are committed you must check them out as best you can. The professionals call this process 'due diligence'.

Verifying the Information You Have Been Given

You cannot simply rely on the accountants who produced the accounts. Firstly, you do not know what level of verification they carried out in producing them. A full audit is rarely required these days, unless it is a limited company with a high turnover. The accountants will always include a certificate in the accounts which will state the level of checking they have done. Often the certificate states that 'in producing the accounts we have relied on information supplied by the proprietors', and goes on to state that no independent verification has been carried out. In other words, rely on these accounts at your own risk. Most accountants do check things somewhat, but unless there is a full audit certificate you could never successfully sue them if you relied on accounts that you subsequently discovered were untrue.

In any event, the latest annual accounts will cover a period that ended a long time ago, so you will need to verify the management trading figures you have been given for the period since the last annual accounts - these are the latest and definitely most important since they cover current trading.

So, what should you do? Obviously you cannot check every bookkeeping entry, but there is much you can do to satisfy yourself.

You can ask your accountants to do this for you and, if the sums involved are substantial relative to your financial situation, then having them involved would be a wise precaution that is highly recommended. However, it is also highly recommended that you maintain an involvement in the process yourself, especially if your accountants are not experienced in running businesses themselves. Many accountants, whilst excellent technically in accountancy, are not sufficiently streetwise not to be taken in by a dishonest businessperson setting out to pull the wool over their eyes. Therefore, get involved yourself, and ensure that at least the steps outlined in this chapter are taken to verify the trading figures.

Ask to speak with the existing accountants to the business

If the vendor has nothing to hide he should have no problem with this. If you are doing the verification without your accountants, the current accountants are probably hoping that they will continue to be doing your accounts when you take over, so they are likely to be helpful. Engage them in chat as much as possible to see what general comments transpire.

They will probably know quite a bit about the business, and you will gain an overall impression about their professionalism. Ask them what they do to produce the accounts. They might tell you that they effectively write up the accounts from scratch, in which case if you trust them as people you probably trust the accounts. On the other hand, they may say that they get books written up by the owner which they convert into final accounts for the taxman, but they do little more. If it is the latter, ask them how good the accounting systems are at the business. If they say, 'You don't have to worry about John, he accounts for everything down to the last penny,' then fine, but if they are cagey you have been warned!

Depending on how much the accountants do, it will be appropriate to undertake all or some of the following tasks with the accountants or with the owner:

Check the bank accounts

Ask to see the original bank account statements for at least the last two years. You can check a lot of things looking at these:

Turnover - add up the credits going through the account. Do they roughly amount to the sales figures you have been given?

• Expenses - look at the direct debits/standing orders. Rent, electricity/gas bills, telephone bills, business rates, etc., will be paid through the account. Do they look similar to the amounts shown in the accounts?

• Bounced cheques! Does the account look healthy? If the owner is selling because he can't make ends meet, it will show. It doesn't mean that you don't want to buy the business, but you need to know why he is under pressure. It may be entirely personal financial pressures, in which case you may have a really good opportunity here.

Check the VAT returns

The owner should have kept copies, which will show turnover declared and expenses claimed for VAT. You will need to review the returns for all the periods covered by the accounts (at least two years if it is an established business). The total sales declared on the returns should be consistent with the accounts you have been given.

The returns will show the net amount paid in VAT to the Government, or refunds received. Double check that the returns are genuine by checking that there are paid cheques, or credit entries, in the bank statements for each of those amounts.

Check purchase invoices.

Check that volumes are as expected, and that prices are as well. If the vendor has told you that toys make a 33 per cent mark-up for example look at some invoices and check the unit prices against sale prices on the shelves.

If you have been told that the business receives credit from its suppliers, check whether the invoices indicate the credit terms you have been told the business gets. Most companies show the due date, as well as the invoice date, on their invoices. You can do a quick calculation to check the overall average credit received from suppliers, the formula being:

average days' credit received = total creditors x 365 annual purchases

So if annual purchases are $250,000 and total creditors outstanding stand at $65,000:

65,000 * 365 = 95 days 250,000

Obviously this is only a rough guide as there could be variatic according to the time in the month the calculation is done, ant is no substitution for a detailed physical check of the original invoices. However, it will certainly show up any significant variation from what you have been told.

Spend some time at the business

The vendor may be worried about staff finding out that he is selling, and may not be keen for you to spend time there for the reason. However, if you can, be around and watch what is going on. Keep a mental note of what is going through the till, for example. If it's a pub or cafe, it should be easy to sit in a corner and just watch and listen - are the staff good, the customers happy, is the till ringing up as much as you would expect?

For businesses with trade customers

You need to know how dependent the business is on selling to a few large customers. This is a much more common problem than dependency on suppliers.

Ask the vendor who the biggest customers are and what percentage of total sales they represent. Ask to see the records to verify the answers.

Obviously, a business that has a high proportion of its trade with a few large customers is much more risky than one with a wide spread of small customers. If one or two customers account for 25 per cent or more of sales, was this what you were expecting? Are those customers loyal to the vendor personally and likely to go elsewhere when he leaves?

If the business sells on credit, you need to know whether the term of credit given is what you have been told. It is easy for the vendor to say that his terms are thirty days but, if most of the customers are taking sixty days to pay, he is in reality giving sixty days. A quick check on the overall situation can be easily calculated. The formula for working out the average number of days' credit given is:

average days' credit received = total debtors x 365 annual sales

If the total outstanding debtors are $50,000 and the annual turnover is $450,000 the calculation is:

50,000 x 365 = 40 days 450,000

Obviously forty days is an average. If particular customers are being very slow to pay, perhaps you should look into whether they are worth having. If they amount to a significant proportion of turnover, you may wish to recalculate what you think the business is worth.

You should be able to verify whether the business has many customers who are very slow payers. The vendor should be able to supply you with a report of outstanding invoices showing how they are. If their invoices are factored, and the credit com function is handled by the factoring company, there should reports produced by the factoring company to look at.

Remember, if you have done your cash flow calculations based on the business giving thirty days' credit, and in reality they giving an average of forty-five days, you are going to need en working capital.

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