Buying and Selling a Small Business - Part 2 Sources of Information for Buy-Sell Decisions

Chapter 3 - Sources of Market Information

"What kinds of information do I need?"
"Where can I get this information?"

The information needed can be grouped into three general types: (1) market information, (2) financial information, and (3) legal information. The purpose of this chapter and of chapters 4 and 5 is to identify still further, within these groups, the kinds of information the buyer or seller should look for and some sources of that information. Not all of the sources listed will apply equally to all kinds of businesses. The buyer or seller will have to determine for himself the extent to which the specific types of information will help him reach a sound decision.

Some difficulty may arise in the information-gathering stage because of poor records, unavailability of some information, lack of cooperation, and the like. The seller has the advantage as far as internal data are concerned. He has free access to his own records; the buyer does not. If the buyer needs internal information to reach a decision, it should be made available to him. He should insist on seeing the company records and be wary of any seller who refuses to give him the information he needs.

Either seller or buyer may have to spend considerable time and effort digging out the information. The sources suggested below, however, should help him gather the basic types of information needed in the decisionmaking process.

Importance of Market Information

A market analysis should indicate whether the purchase or sale of the business should be considered further. It will help the seller decide what valuation to place on the business for sale purposes. It will help the buyer decide how much he should pay, and it will also give him a clearer picture of just what he is buying. A market analysis has the added value of making it possible to develop more accurate sales forecasts. It places greater emphasis on fact and less on hunch and guesswork.

The specific nature of the business being bought or sold will determine much of the market information needed. A manufacturing business with problems of marketing and distribution will need information not necessarily pertinent to a retail or service business, with its more localized market. The following areas of market information are designed to suggest sources that may be useful to the buyer or the seller in analyzing the market of the business.

Sales Information

The manner in which the records are kept will determine to a large extent the availability of sales information. Many small businesses keep little in the way of sales records--often only what is necessary for tax purposes. Others have bookkeeping systems designed by business-machine manufacturers, trade associations, or professional accounting services. The more standardized the procedure, the more useful the information is likely to be for market analysis.

Most States now have sales taxes, and this may provide a useful source of information. Whether or not a business is required to keep sales-tax records depends largely on the type of business and the State requirements. Sales-tax laws are not uniform, and what is required in one State may not be required in another.

If most of the business is done on a credit basis, accounts receivable may give useful sales information. If this source is used, the market investigation should be concerned only with the amount of credit sales and not with the effectiveness of the collection of accounts receivable.

Ingenuity and common sense can often turn up sources of sales information. In one case, for example, sales for a self-service laundry were determined by using water capacity per machine, city records of the amount of water consumed by the business, and price per load.

Regardless of where the sales information comes from, the purpose of gathering it is basically the same--to identify the pattern or trend of sales over the past and to use this information to project or estimate sales for the period ahead. Such an investigation is especially useful in determining the value of the business above the value of the assets.

Cost of Goods Sold

Many factors, both within the company and in the market of which the business is a part, affect the cost of goods sold. An investigation should be made to determine the following:

1. Average rate of stock turnover, particularly as compared to the normal or typical rate for similar businesses.
2. Extent to which invoices are being discounted. Paying invoices in time to earn the cash discount will increase both gross margin and net profit if the discount is recorded as a reduction in the cost of goods sold. A direct increase in net profit will result if the discount is shown as "other income."
3. Freight costs to determine whether incoming transportation charges are in line. Among the records to be studied are vendor invoices, records of merchandise payments to vendors, shipper receipts or bills of lading, and records of past physical inventories.

Sales-Effort Records

The purpose of gathering information on selling costs is to determine how well these costs are being utilized and to compare them with average figures for the kind of business being studied.

Personal Observation

The general appearance of the premises, both internal and external, may be important, particularly if direct customer contact is made at the place of business.

Plant layout and apparent efficiency of operation should be carefully observed if the seller is a manufacturer or otherwise engaged in processing or assembly.

Employee morale and general attitude toward the business should be noted, especially if current employees are to be retained.

Employee records, including wage-payment plans, employee-evaluation and merit rating programs, training programs, and so on should be studied.

Market Information From Outside Sources

Competition. Unless the business has a monopoly of some sort, a study of the competition should be included in the market analysis. The competition may be local and well defined, or quite generalized, depending on the nature of the business and of the market.

Trade associations and other data-gathering agencies, both governmental and nongovernmental, are sometimes helpful in this area. A good deal of the information about competition, however, must come from direct investigation, business by business.

Such factors as these are of interest: estimated sales, advertising and promotion, services offered, performance of sales personnel, businesses entering and leaving the competition recently, changes in the competitive structure through product mix or services offered, pricing policies, and other factors that form a part of the competitive patterns for specific types of businesses. A very important aspect of competition is the extent to which the total weight of competition has expanded the market for certain types of products or kinds of businesses, and the direction this is taking.

Location. In certain businesses, location may not be too important, providing the physical plant is structurally sound and suitable for the business. In other cases, location may be a vital factor. An important point that should be looked into is the status of the location and any plans for proposed changes that may have an adverse effect on the future of the business. Urban renewal programs are causing many small businesses to look for new locations. So are changes in highways and streets, flood-control programs, changes in zoning ordinances, and the like.

The buyer, whether he will own the physical plant or lease it, should look into the possibility of future expansion. Consulting a competent architect or engineer now may save trouble later on if the buyer should want to expand and leasing provisions allow him to.

Population and purchasing power. The number of people within the market area and the amount of spendable income they have are important market factors. For many kinds of businesses, the total population is less important than certain segments of the population. A business selling hearing aids, for example, will be interested only in persons who have hearing difficulties.

In gathering information on income and expenditures, three factors should be kept in mind: (1) the total purchasing power based on total population; (2) the average or median income for the typical family unit; (3) the amount or percent of expenditures for various types of goods and services.

General population figures are obtained from Federal, State, and local government sources. The Federal census, taken every 10 years, gives not only total population figures but also breakdowns that are useful in many business situations. For most of the larger cities, census figures are further classified by sections within the city on the basis of certain population and economic characteristics. These sections are called census tracts.

Business population figures may be available from numerous sources. The Yellow Pages of the telephone directory and the city directory are local sources that are immediately available. Chambers of commerce, trade associations, and State and Federal government agencies can often be helpful. The 10-year census reports the income for 20 percent of the total population on a National, State, county, city and census-tract basis. Other information issued by the Department of Commerce can also be useful.

Many trade associations report the results of research on consumer expenditures. Other sources of data on income include the following: (1) planning commission offices, (2) employment offices, (3) research done by newspapers, (4) building permits, especially in newly developed areas, and (5) mortgage and loan companies. Numerous fact-gathering agencies develop and publish estimates of consumer income and expenditures for various classes of goods and services.

General market conditions. A much broader yet vital part of the market analysis has to do with what might be called the general state of the market. Most of the discussion of market analysis so far has dealt with factors that have a direct influence on the business being bought or sold: company sales, location, competition, and so on. But these, in turn, are influenced by the overall economic conditions of the country and of the market area. These may be widespread movements such as national cycles of prosperity and depression, or they may be purely local conditions. The two extremes are not necessarily related.

It is to the advantage of the buyer or seller to have a clear understanding of economic factors that affect or are likely to affect the status of the business. The significance of this information becomes clearer when forecasts and estimates are made.

Some questions to be used as a guide in market analysis are given in chapter 12.