Determine your budget when buying a business

This will be determined by your ability to manage the businesses monthly cash flow, your cash reserves, equity you may borrow against, the bank and/or vendor finance. Exercise care in not taking on too much debt, and ensure you allow for working capital and some cash reserves.

As with anything, we are usually attracted to the best and most impressive looking car, boat, house or business, seeing the lifestyle it can provide. This usually leads to looking at high profit businesses, and with that usually comes the higher price tags. So maybe you are able to extend yourself - you're got the vision, enthusiasm, and a lot of good ideas to implement. Unfortunately there are also a lot of variables in the business world, a number of which can and do lead too failure, so it's important to determine your budget when buying a business.

The best position is to reduce your risk. Don't spend the lot, struggle to keep things afloat, and then risk loosing it all. Exercise common sense, spending less will reduce your risk. Additional monies can be used at a later stage to expand or grow the business, once you have a thorough understanding of what the business takes.

Obviously, every business purchase is situation and business specific, therefore difficult in determining how much should be spent.

Here are some general guidelines:

1. You need to consider all the factors; don't over look the monthly cash flows, sufficient working capital, possible vendor finance, and the professional fees.

2. Always keep some in reserve for that rainy day - look to what could be your biggest and most likely contingencies, and manage this risk. It is likely to require putting away some cash reserves as a safe guard in those early more vulnerable years.

3. Initially borrow more than you need, this will be the easiest time to get funds - if in 12 months time your new business is struggling and is in need of a cash injection. The bank is highly unlikely to want to lend you more. This could be by way of additional funds borrowed but not drawn on, or establishing a good overdraft facility at the time of purchase. Keep this in place until you're comfortable that you can financially manage your way through the ups and downs.

4. You're likely to be borrowing against assets. When doing this look to maximise your borrowing against the new businesses assets - this may require using the services of a Finance company. It's always easier and cheaper to borrow against the family home - but it may not help you sleep easily.

5. You're also likely to need some bank financing. Banks are risk averse; they like houses and are nervous on businesses. Business borrowings are therefore likely to be secured against family homes (where possible), or other key assets. They will want your proposed business able to generate sufficient cash flow after expenses before they give you a loan. After all they want to see you can meet your financial obligations. Banks are an important part of the equation, they;

(a)
Will usually look at the interest cover, one such calculation is;
(net profit + interest costs) / interest costs = interest cover.
Ie. ($30,000 + $16,000) / $16,000 = 2.8
Anything less than 2 suggests the business has too much debt.

(b)
Want security, and will usually lend only 45 - 65% on the tangible business assets valuation, depending on the perceived risk in having to cash-up the particular asset. Want to see 3 years of trading trends, and are generally more comfortable lending on proven franchise systems as this factor tends to improve a businesses success.

Strengthen your bargaining position before you find your business to buy...
Find out how much business finance you can borrow and determine your budget before buying a business.

By Richard O'Brien - nzbizbuysell
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