At Finn Business Sales, it’s no secret we advocate for having the right expertise around you when buying a business. As a prospective buyer, you’re likely to wear a few hats. Everything from a researcher, data analyst, market trend expert and financial specialist. A key part of navigating this journey is being aware of any financial red flags and responding accordingly.

Today, we’re taking a look at the potential financial pitfalls that could occur before you sign the final contract. Remember, this isn’t just about trusting your gut, but keeping an eye out for potential shady behaviour. Let’s take a look at 4 critical financial signposts you’ll want to avoid and the logic behind them.

Inconsistent record keeping

Part of the process of acquiring a business (especially when you’ve put in an offer) is the all-important due diligence. This is your time to dig deep into the existing business records and to ask questions if something isn’t clear. A successful business will always maintain clear financial records no matter how big or small. You’ll want to look out for discrepancies, major holes in timeline records or a reluctance to share specific information.

These financial red flags could signal bad business practices (the results of which could fall on your shoulders if not correctly managed). Take your time reviewing the financial records, and remember – there’s no stupid questions in this scenario.

Rollercoaster revenue & profits

They often say the path of least resistance always goes downhill. Ask questions about financial red flags such as a sharp drop in revenue and profits. Of course, low revenue and profits during a period (especially within a startup) doesn’t always mean something is wrong. A seller could be burnt out, wanting to retire, or has lost interest in the business, hence wanting to sell. These are all reasonable reasons why a drop in revenue has occurred. If a business is looking to sell, an explanation for a drop in revenue over time from the seller will give insight on getting the business back to running at its premium performance. Take time to ask the broker questions relating to any financial challenges. This way you will know if these challenges can be overcome, or if the business requires a new structure.

Supplier or customer dependence

Relationships are critical to running a successful business. However, there are scenarios where relationships (with both customers and suppliers) can get too close to comfort. As you’re reviewing the financials of a business you’re looking to invest in, look out for any overdependence on a specific customer or a key supplier unless there is a secure ongoing contract in place. For example, if a landscaping firm has seen ongoing revenue from a government grant, they may appear successful. However, this contract could wrap up in 2025, leaving you on the hook to sure up further business.

In the same way, if the business hinges on a key supplier (on or offshore), there’s always a risk that their supplier could up their costs or be bought out by another in the market, leaving the business vulnerable to low stock. A customer and supplier base lacking in diversity is something to consider. 

Cash isn’t always king

We’ve all heard of businesses that operate – how shall we put it – under the table. Perhaps you’ve even worked for one in your younger years. A few hours waiting tables at a local family restaurant, and some cash in hand. While it can seem tempting as a business owner, mysterious cash flow can be a financial red flag. Ask your broker about any cash taking within the business to clarify the revenue performance overall. However, be aware that if you are seeking financial support from a lender to purchase a business, cash can not be taken into consideration. 

As a prospective business buyer, recognising financial red flags could be the moment you save yourself from financial and emotional stress. A proficient business broker will enable you to tap into an expert team to support you across the financial review process. A broker can ask those sometimes-awkward questions for you and be there as your sounding board to get a reasonable perspective. 

No matter how you choose to buy a business, ensure you engage professionals like financial advisors and legal experts during the due diligence process. Paired with your own discerning eye, you’ll set yourself up to own a profitable venture which will be rewarding both financial and entrepreneurially. 

Next time in this series, we’ll talk about people power, and red flags in the managing team (from the GM all the way to the service staff) to keep an eye out for.