I confess I’m not much of a one for Twitter, but these series of tweets from @SievaKozinsky are so good I thought I’d share them, writes David Little, a partner in our Corporate and Commercial Law team.
Sieva is a serial entrepreneur, investment analyst and blogger based in San Francisco. These series of tweets relate to what he describes as ‘profit and loss accounts’ (P&Ls), but they equally apply to Annual Reports, which across the Corporate & Commercial team form an important piece of intelligence for any client we are working with, either as buyer or seller.
Here are 5 key things Sieva – and I – suggest you look for in an Annual Report:
- Is gross margin around 40%, or higher? Any lower indicates the company is likely underperforming. Monitor a company’s gross margin over time. Is it improving or getting worse?
- Dig into variable costs, large or odd variable costs are likely a red flag that the business isn’t managing expenses properly. Plus, they’re much tougher to budget for. Watch these in past P&Ls. Are the variable costs consistent? Or do they fluctuate wildly?
- Payroll can show where profits are going. Compare payroll to gross margin over the span of years and months. Is that margin being compressed over time? If margin is eroding due to payroll it’s a red flag.
- Revenue trends. Is revenue growing steadily or is it inconsistent? Small businesses are unpredictable, so don’t expect a clean line. But you can draw a trend line across many months and see if the business is trending up. As a rule we avoid businesses in decline. Same thing in the opposite direction. Some businesses are running too lean. When you buy them you will need to add staff. Make sure you do due diligence on how you’ll need to run the business if/when the owner leaves.
- Depreciation is a cost to your business. Don’t add it back when you’re calculating a valuation for the company. Assets are being worn out, and you’ll need to replace them. Look at the last 5 years. Has yearly depreciation gone down or up? Inspect why that is.
As I said, well worth thinking about, once you’ve got past the Chairman’s Statement!
Contact our Corporate & Commercial Solicitors
David Little is a Partner at Bishop & Sewell in our expert Corporate & Commercial team. If you would like to contact him, please quote Ref CB403 on either on either 07968 027343 / 020 7631 4141 or email firstname.lastname@example.org.
The above is accurate as at 22 June 2023. The information above may be subject to change.
The content of this note should not be considered legal advice and each matter should be considered on a case-by-case basis.