For example, say you decide to acquire a business for four times its future maintainable earnings. This would indicate you are prepared to pay $4 million based on the reckoning that you will buy an income stream (the profit or future maintainable earnings) and require a 25 percent return on your investment given the risk profile of the business.
If you haven't been provided with any working capital, you will automatically come across a hurdle. How will the bills be paid in the first week of trading?
Staff wages, rent, loan repayments and so on must all be paid immediately, whereas sales from this newly acquired business are most likely to be largely on a credit account. So, as the acquirer, you would need to fund the working capital in addition to the purchase price. This of course means there is more than $4 million at risk and would indicate that as the purchaser, you have paid more than you should have! A good understanding of working capital will help avoid trouble.
Michael Sutherland is director of Entrepreneurial Services, with Grant Thornton (
www.grantthornton.com.au).
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