The more brilliant your idea is, the easier it is to believe that everyone will want to buy it. You would never buy a business from someone else without investigating it thoroughly (well, we hope you wouldn’t). But how often have you done due diligence on your own, up-and-running business, or, equally importantly, have you done due diligence on the business you are preparing to start?

The simple truth is that every business should be able to pass due diligence, that is, score a pass rating when it is examined for the Key Indicators to Business Success. Let’s look at how we arrive at two of these indicators:-

1- The Current Ratio – this is the ability to pay all its financial obligations in any reasonable period, essentially the ratio of income to expenditure.
• The pass rating will be between 1.5 and 3.0
• A ratio of lower than 1.0 means that insolvency is a serious consideration. One must examine whether the business is, in fact, able to generate an adequate income stream and whether the facility exists to collect accounts receivable.
• A ratio of more than 2.0 suggests that the business is not utilising enough of its income stream to finance growth. Nothing stays the same if your business does not expand to fill any gap, the competition will.

2- Return on Equity – this is the ability to generate revenue for each unit of shareholder equity
• The Net Income as a percentage of Shareholder Equity should be 15% to 20%. But remember that if this business is consuming your working life, then it must pay you an appropriate salary first, and then produce a dividend.
• This becomes particularly important in a very small business. If the operation is financed by a large chunk of your assets, and simply generates a salary for you, then it would be much wiser to get a job running someone else’s business and leave your money invested elsewhere.

Most importantly, this due diligence must be conducted in an unemotional, accurate manner. Even the business you love can lead to bankruptcy.

For assistance on analysing your business idea before you get started; or for ways to turn your existing business around, please get in touch for a complimentary initial consultation.

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