Reading a business's financials before you buy

For a first-time buyer, a seller's financial statements can be intimidating less because the accounting is complicated and more because it is unfamiliar. Knowing roughly what to look at first, and which numbers tend to need the most scrutiny, makes the rest of the review considerably less daunting.

Start with the shape of the business, not just the total

Revenue and profit totals matter, but how they are made up usually matters more. Two businesses can report similar revenue while one earns it from a handful of large, price-sensitive contracts and the other earns it from hundreds of smaller, recurring customers. A buyer generally wants to understand not just how much money came in over the past few years, but where it came from, how steady it has been year to year, and how much of it is reasonably likely to continue after a change of ownership. Financial statements for a small, owner-operated business also rarely reflect what a new owner would actually experience, since many owners run some personal or discretionary expenses through the company, or pay themselves in ways that do not map cleanly onto a market wage. Buyers and their accountants typically build a normalized earnings figure, often called seller's discretionary earnings or an adjusted EBITDA depending on the size of the business, by adding back these items to get a clearer sense of the cash flow actually available to a new owner.

Common adjustments, and a few things worth a closer look

• Owner compensation, benefits, and any personal expenses run through the business
• One-time or non-recurring items, such as a lawsuit settlement or a one-off equipment sale
• Related-party transactions or non-arm's-length pricing, including rent paid to a property the owner also owns, that would not hold once ownership changes
• A gap between what is reported on the financial statements and what was filed with the CRA or reported for GST/HST, which is worth understanding rather than dismissing
• Accounts receivable growing faster than revenue, which can point to slower-paying customers or collection issues
• Rising inventory levels without a matching increase in sales
• Loans to or from related parties, shareholders, or other companies the owner controls
• Margins that move significantly from year to year without an obvious explanation

Buyers commonly compare the normalized earnings figure against the purchase price being asked, though it is only ever a starting point rather than a fixed answer, since two accountants reviewing the same books can reasonably normalize a few borderline items differently, and it is worth asking how consistently a seller has applied add-backs from year to year. None of the items above signal on their own that a business is a bad opportunity. They are simply the kinds of questions worth raising with the seller, ideally alongside an accountant who can help interpret what the answers mean for the specific business, and a buyer who understands roughly what they are looking at going into due diligence tends to ask sharper questions and move through the process with more confidence, even before the more formal due diligence stage begins in earnest.