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Learn the difference between an asset and profits in business values

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While this may sound like an odd question, rest assured you will encounter arguments for both answers while you’re in the process to buy a business. I’m sure you’ve heard the saying, “There’s no such thing as a dumb question.” –  that may be true, but there are certainly dumb answers.

Before we get into both sides of the question, imagine this scenario…

Bob and Mary walk into the bank to pay their respective business loans. Mary gives them a check, gets a receipt for her payment and is done. Bob on the other hand wheels in a huge piece of equipment he uses to produce the widgets he manufactures. He informs the teller he wants to pay his loan. When she asks for his payment, he points to the equipment and says, “I’m going to give you that production unit – it’s worth more than the money I owe”. Do you think the bank will accept it?

Assets do not pay the bills!

Your accountant will almost certainly pay more attention to the company’s assets and discuss their perspective of the business based upon the balance sheet. Certainly that statement is important, but in reality there are a few things to consider.

First, assets are a means to generate revenue. Think of it this way – an asset-rich business that does not generate profitable sales isn’t really very valuable is it?

Second, the assets play a role if you’re looking to obtain third-party financing. A lender wants to know that the assets can cover the loan if they have to be liquidated. The fact however is that few small business sales involve bank financing and so here too this is a bit misleading.

Third, from both the accountant’s and bank’s perspective, their thinking is somewhat unrealistic because if you have to liquidate the assets, they will rarely sell for what they’re valued for in the overall deal.

Now let’s consider profits and the argument is very simple: The more profit the business generates, the more it will have available to pay you, service debt and invest in the business to market the company and in many cases, to pay for new equipment that may be needed to sustain or grow the business.

Obviously, some businesses need assets to generate the revenue, but don’t get consumed by assets relative to the importance of profitability. The majority of small businesses for sale don’t have a lot of assets. Further, many service businesses have none at all outside of basic office equipment.

As you look at potential businesses to buy, pay attention to the assets but remember, it’s the profit and ONLY the profit that will pay the bills.

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