Due Diligence, sole trader - help please :o)

[BBsas]

Hi, new member here, seen some good advice handed out on here during my brief scan having just found you..
(posted in two forums hope thats ok)
A potential business opportunity has come up through whereby I can buy a franchise retail outlet that has traded in the same location profitably for 14 years. The potential transfer of the franchise itself (ie right to trade using their name) into the incoming owners' (me, hopefully) name has been confirmed via email by the franchisor, subject to payment of a 20 year renewal fee which is due anyway. The vendor, who operates two such stores as a sole trader, is known to me and very much established in his business: his own plan following our deal is to concentrate on running the remaining store - so I would benefit from his assistance in the first months/ years of operating.
I have had a preliminary look at the paperwork concerning the last few years accounts, however, the vendor is a sole trader who produces his own accounts with consummate ease (he also does the accounts for some other outlets operated by the same franchise). Everything appears very neat tidy and in correct order, and I have many reasons to rely on the vendors good faith, however, of course I want to verify the key facts and figures.

However, at this precise stage taking along a professional auditor of some kind may seem like overkill; the vendor is known to me, and the accounts are incredibly straightforward and laid out neatly etc. I really want to spend some time getting to look at the paperwork more closely by myself.
Among his accounts there are VAT returns and presumably all the necessary paperwork is present somewhere, but please advise me, what the key information i should be looking at as a priority? I don't mean really obvious things like turnover, gross/ net profit etc. I mean the less obvious paperwork that, when cross checked against his hand-written figures, ideally corroborates the figures shown in his hand written summaries. I would like to know for sure how much he has been paying his employees -- is there any way of finding out conclusively? Dumb as it sounds to ask, I would like to know if VAT returns actually show REAL figures relating to VAT paid, and any advice how to decode those VAT returns to distil useful info would be helpful as hell. Any other info which isn't solely dependant on his accounting, any other ways to perform diligence or key figures to cross check, advice really appreciated.
Basically I am on a time-limited mission to establish, verify and double-verify as much info as possible, preferably by myself as it really isn't that complex and I'm a quick learner.
One other area of concern worth noting is that as he runs TWO identical businesses side by side, what are the obvious traps i should avoid falling into considering that quite often, the two outlets figures etc are presented side by side, and some aspects of the info on display pertains to both outlets (though they are accounted for separately, tho must admit i need to double check on that).
There are many other questions i have but i'll take this one as most important, thank a lot any help..

 

[BBsas]

Hi, new member here, seen some good advice handed out on here during my brief scan having just found you..
(posted in two forums hope thats ok)
A potential business opportunity has come up through whereby I can buy a franchise retail outlet that has traded in the same location profitably for 14 years. The potential transfer of the franchise itself (ie right to trade using their name) into the incoming owners' (me, hopefully) name has been confirmed via email by the franchisor, subject to payment of a 20 year renewal fee which is due anyway. The vendor, who operates two such stores as a sole trader, is known to me and very much established in his business: his own plan following our deal is to concentrate on running the remaining store - so I would benefit from his assistance in the first months/ years of operating.
I have had a preliminary look at the paperwork concerning the last few years accounts, however, the vendor is a sole trader who produces his own accounts with consummate ease (he also does the accounts for some other outlets operated by the same franchise). Everything appears very neat tidy and in correct order, and I have many reasons to rely on the vendors good faith, however, of course I want to verify the key facts and figures.

However, at this precise stage taking along a professional auditor of some kind may seem like overkill; the vendor is known to me, and the accounts are incredibly straightforward and laid out neatly etc. I really want to spend some time getting to look at the paperwork more closely by myself.
Among his accounts there are VAT returns and presumably all the necessary paperwork is present somewhere, but please advise me, what the key information i should be looking at as a priority? I don't mean really obvious things like turnover, gross/ net profit etc. I mean the less obvious paperwork that, when cross checked against his hand-written figures, ideally corroborates the figures shown in his hand written summaries. I would like to know for sure how much he has been paying his employees -- is there any way of finding out conclusively? Dumb as it sounds to ask, I would like to know if VAT returns actually show REAL figures relating to VAT paid, and any advice how to decode those VAT returns to distil useful info would be helpful as hell. Any other info which isn't solely dependant on his accounting, any other ways to perform diligence or key figures to cross check, advice really appreciated.
Basically I am on a time-limited mission to establish, verify and double-verify as much info as possible, preferably by myself as it really isn't that complex and I'm a quick learner.
One other area of concern worth noting is that as he runs TWO identical businesses side by side, what are the obvious traps i should avoid falling into considering that quite often, the two outlets figures etc are presented side by side, and some aspects of the info on display pertains to both outlets (though they are accounted for separately, tho must admit i need to double check on that).
There are many other questions i have but i'll take this one as most important, thank a lot any help..

 

[Psl]

Ask him for the bank statements relating to the business, if there is nothing to hide he will let you have them, if has somethiing to hide, he won't.

 

[BBsas]

Ask him for the bank statements relating to the business, if there is nothing to hide he will let you have them, if has somethiing to hide, he won't.

Thanks for speedy reply, I don't see a problem there, but there are hopefully several other measures to verify key facts hopefully?

 

[Psl]

Thanks for speedy reply, I don't see a problem there, but there are hopefully several other measures to verify key facts hopefully?

How much cash does the business take and is it all declared? Ask him straight.
He needs to calculate his VAT, where does he source the figures from to complete these VAT returns?

 

[BBsas]

How much cash does the business take and is it all declared? Ask him straight.
He needs to calculate his VAT, where does he source the figures from to complete these VAT returns?

Thanks for reply..Turnover between 110k p.a - 130k roughly depending on year, and yes, it is all declared, but when you say where does he source those figures..i don't know what you mean. His handwritten summaries obviously contain key figures but there are also official VAT returns present, etc.
Its not a dodgy business at all but i do need help deciphering the key info.

 

[BBsas]

How much cash does the business take and is it all declared? Ask him straight.
He needs to calculate his VAT, where does he source the figures from to complete these VAT returns?

I assume the sales cash figures are basically generated via the till receipts, and would greatly appreciate advice how to analyse actual till receipts (should i request to even see those...?) and if so, ways of verifying that they pertain correctly to the headline figures.

 

[Psl]

I assume the sales cash figures are basically generated via the till receipts, and would greatly appreciate advice how to analyse actual till receipts (should i request to even see those...?) and if so, ways of verifying that they pertain correctly to the headline figures.

Analysing till receipts, I wouldn't know where to start, someone on here will though.
Can we take it that he doesn't use Sage or some such accounting software?
If he doesn't then that sounds a lot of paperwork to trawl through to get the answers you want, unfortunately.
There has to be calculations and workings to arrive at his figures for his VAT return, where are these?

 

[Scalloway]

There should be a paper trail. Files of invoices paid and issued that are listed and summed to produce figures that go into the trial balance, VAT returns, bank reconciliation etc.

There should be deduction sheets for every employee that tie up to wages paid and PAYE/NI paid.

 

[BBsas]

Analysing till receipts, I wouldn't know where to start, someone on here will though.
Can we take it that he doesn't use Sage or some such accounting software?
If he doesn't then that sounds a lot of paperwork to trawl through to get the answers you want, unfortunately.
There has to be calculations and workings to arrive at his figures for his VAT return, where are these?

I presume he doesn't use Sage ..the business model is a very simple one; single product, walk in sales, mostly cash as the average purchase is quite small, a few pounds usually. I am having another meeting Friday and will discover the calculations and workings you refer to, (and re-post then) but the main reason i need help is precisely because Fridays meeting is going to be another chance to pore over the paperwork and i need clues what to pay particular attention to..
Many thanks for advice and replies!

 

[BBsas]

Also, if anyone has a specific reply on the question of how i can cross check the amount of wages he has paid out to employees over the years? This is a very important matter ot cross check, as the profits of the business depend to quite a large degree on how much help one gets to fill up the weekly opening hours.
I will work a similar pattern to his probably, but really want to check if he has usually been employing someone, and ideally i would LOVE to check how much he has paid them -- verifying that, alone, would make me much more comfortable with accepting that aspect of his overheads column.

 

[BBsas]

There should be a paper trail. Files of invoices paid and issued that are listed and summed to produce figures that go into the trial balance, VAT returns, bank reconciliation etc.

There should be deduction sheets for every employee that tie up to wages paid and PAYE/NI paid.

Deduction sheets -- thanks a lot. Will check for these carefully, as I really want very much to verify how many employees he's taken on over the years and at what sort of wages..this is a key issue for me.
Bank reconciliation, trial balance, these are terms which i am 99% certain won't appear anywhere in his very basic, but supposedly extremely accurate paperwork. He will however, provide anything reasonable i ask of him i think.

 

[Billmccallum]

Much depends on the type of systems the business uses, if the cash register provides daily print-outs of takings (Z read normally), these can be summed up to provide weekly, monthly, annual total sales.

Most of the income (one would assume) would be banked daily and pay-in slips from the bank account and bank statements would back up the data from the Z reads.

How the staff are paid will dictate how you analyse employee costs, most employers pay by BACS, but some still do cash weekly, either way you would expect to see copies of all wage transactions, these would be tallied with the P14's (end of year summary for wages).

Total sales should roughly tally with invoices for purchases, for example if the annual gross profit margin is 50%, you would expect to find invoices to the value of 50% of the total sales.

If you are comfortable in your ability to read the data and interpret the conclusions you should be able to make a judgement yourself. On the other hand if you don't feel that you can or would be able to do so in a reasonable time frame, it mat be best to get someone with financial management skills to look them over for you.

This does not have to be an auditor, anyone with a good financial background should be able to do this quite easily.

 

[BBsas]

This is a fantastic reply and exactly the type of reason i joined... really grateful. There is no limit to the kind of info i'm seeking to drink in currently but that was brilliant thanks a lot.

 

[Arch Stanton]

Hi

If the vendor runs two identical outlets what is to stop his existing customers, of the outlet you are going to buy, going with him to the other outlet?

 

[BBsas]

Much depends on the type of systems the business uses, if the cash register provides daily print-outs of takings (Z read normally), these can be summed up to provide weekly, monthly, annual total sales.

Most of the income (one would assume) would be banked daily and pay-in slips from the bank account and bank statements would back up the data from the Z reads.

How the staff are paid will dictate how you analyse employee costs, most employers pay by BACS, but some still do cash weekly, either way you would expect to see copies of all wage transactions, these would be tallied with the P14's (end of year summary for wages).

Total sales should roughly tally with invoices for purchases, for example if the annual gross profit margin is 50%, you would expect to find invoices to the value of 50% of the total sales.

If you are comfortable in your ability to read the data and interpret the conclusions you should be able to make a judgement yourself. On the other hand if you don't feel that you can or would be able to do so in a reasonable time frame, it mat be best to get someone with financial management skills to look them over for you.

This does not have to be an auditor, anyone with a good financial background should be able to do this quite easily.

One of the key attractions for me is the fact that the invoicing to a large degree will help to confirm whether the turnover is as he claims it. SLightly complicated by the fact that the vendor operates two identical stores and so therefore presumably overlaps when ordering, at least i can well imagine that being so. (will seek confirmation at next meeting).

 

[BBsas]

One last thing Bill re: staff overheads...it was mentioned that some people do still pay wages in cash, i'm not actually sure if thats the case here, but even if he does, or has previously, presumably he would still retain records of the tax NI etc that he paid on behalf of these employees? And if so...where could i go to check it, if he can't produce any of it, or there are gaps? I'm thinking to investigate the last 5 years carefully...
Because i'm really hoping that whatever exact picture does emerge, i know how to check it with a magnifying glass.

 

[BBsas]

Hi

If the vendor runs two identical outlets what is to stop his existing customers, of the outlet you are going to buy, going with him to the other outlet?

Its a walk-in retail business in a completely different area of London
[edited to remove slightly smug appearing smiley]

 

[BBsas]

I must add that re-reading here, its obvious i would really like to find a professional that could inspect the relevant paperwork and prepare an expert report on the health of the business. Its the very fact he operates two stores (and family members of his run a few others) that makes some of the potential overlapping a bit tricky to assess. overlapping as in, say, group ordering between two or more stores.
His family is in the business as well, these are very respectable business people however, running well recognised businesses. But still makes it a bit cloudier perhaps.

 

[Arch Stanton]

Ah, I see.

Well, you will have to assume the vendor has 'improved' the accounts to make the business appear more profitable and attractive to a buyer. So you need to look for overstated sales and understated costs.

Does the gross profit% look reasonable and how does it compare to similar retail businesses?

As a retail business most of the sales will be via cash or bank. So you should be able to verify the sales in the accounts to the underlying takings records and then to bankings, credit card transaction records etc.

Wages in the accounts should agree to the payroll records but you can also check that employees are being paid from the bank or out of cash. You could also visit the business (more than once) to see how many employees actually work there. This may allow you confirm employee numbers and to estimate the payroll cost and compare it to what is in the annual accounts?

Do the rent and rates in the accounts agree with the premises lease agreement and the council rates bill? Does the lease show any future rent increases? Are other overheads in the accounts enough for the type of business?

What are the vendor's drawings like? Are they enough for you to live on including tax liabilities? If the drawings are high why is he selling?

What is the competition like? If it is increasing is the vendor getting out will the going is good? Can the business maintain the sales levels recorded in the accounts?

 

[Billmccallum]

I must add that re-reading here, its obvious i would really like to find a professional that could inspect the relevant paperwork and prepare an expert report on the health of the business. Its the very fact he operates two stores (and family members of his run a few others) that makes some of the potential overlapping a bit tricky to assess. overlapping as in, say, group ordering between two or more stores.
His family is in the business as well, these are very respectable business people however, running well recognised businesses. But still makes it a bit cloudier perhaps.

Any expert, including an auditor will include a disclaimer in any report to say that they have produced the report subject to the information available to them (which may not be all the relevant data).

The complexity of the business(es) means it will be difficult to assess accurately (having two outlets operating as a single sole trader, with possible links to other family owned outlets).

Whoever does the review will only be able to offer an informed opinion and not a statement of fact.

 

[OldWelshGuy]

merged 2 threads both running.

 

[Drpepper]

Have a look at the VAT returns, they will state both the value of sales and purchases before VAT, so looking at the last four returns will give you the turnover off the business and it's expenses in 2010. All you need to add to the purchases is wages to get the full the expenditure (thinking now if there is anything else that wouldn't be included, there may be but I don't think so, if it's invoiced it'll be included in a VAT return).

Also ask to have a look at his SA return, if he is running these shops as two independent businesses they will be listed individually on his return and again will include everything.

It doesn't sound like he will have any useful or reliable accounts to look at if everything is just hand written and no accounting software used. So the VAT and SA is really your only sure fire way of getting the info you need.

Out of interest what is the franchise?

 

[BBsas]

Have a look at the VAT returns, they will state both the value of sales and purchases before VAT, so looking at the last four returns will give you the turnover off the business and it's expenses in 2010. All you need to add to the purchases is wages to get the full the expenditure (thinking now if there is anything else that wouldn't be included, there may be but I don't think so, if it's invoiced it'll be included in a VAT return).

Also ask to have a look at his SA return, if he is running these shops as two independent businesses they will be listed individually on his return and again will include everything.

It doesn't sound like he will have any useful or reliable accounts to look at if everything is just hand written and no accounting software used. So the VAT and SA is really your only sure fire way of getting the info you need.

Out of interest what is the franchise?

Thanks for this which is also very helpful as a summary. I am still unsure how to verify his records concerning his history of taking on employees in case you/ anyone has any ideas there?

 

[BBsas]

And I hope this doesn't seem at all remiss - but while I would love to canvass opinions on here about the overall perceived viability of the business, it seems a little remiss to go into specific detail on an open forum.

 

[BBsas]

Having just re-read posts which had escaped my attention somehow, it seems that i have some solid advice to go on regarding his employees / wages overheads.
And a thousand apologies for my overuse of the word remiss in my previous post.
The advice has been fantastic so far and i'm really grateful ...but if anyone has more to add they are welcome.
Thanks people!

 

[Drpepper]

Staff wages - ask to see a copy of their P60's, tie these in with his SA and VAT returns and everything should be covered

 

[BBsas]

Update:
Prior to the meeting tomorrow I have spoken with the vendor and managed to put to him several of the queries raised by the kind respondents to this thread. His replies were pretty much as I would have hoped, to summarise:

-he has P60s relating to the wages paid, these go back some years I believe HOWEVER, he does pay wages from cash takings, and pays staff weekly in cash. Don't know whether this raises any real concerns in itself..

-the two shops are connected in the banking sense, but not in any other way, ie, they are accounted for seperately and VAT returns etc are separate to each store.

-he is willing to show me his SA returns, although he points out that the totals shown on them relate to both businesses

-the invoicing from his supplier (the franchisor) -which makes up the bulk of his invoicing - is kept separate for each store

-the z reads are indeed how he calculates the VAT returns etc, these z reads go back 6 years (at least) and are ordered correctly in (i think) weekly bundles and can be inspected at my leisure.

Any further thoughts on any of this from the kind respondents so far, or indeed anyone else wanting to pitch in?
thanks a lot again...

 

[BBsas]

His words re: banking and how the banking is conducted was along these lines:
"say i take 2,000 in a week, but make staff wage payments of say £450. If I also have an invoice to settle with the franchisor, say £500 i might pay that from the weekly takings and bank the remaining £1050".
Kind of the thing I would expect and it doesn't sound dodgy to me ..but any opinions welcome. Thanks again..

 

[Drpepper]

Don't worry to much about the bank accounts, it cost money to pay cash into a bank and as such many of us pay as much "out of the till" as possible. After all there is no point in paying charges to pay cash in just to pay to write cheques out again.

The SA, if he has indeed separated the two shops into two businesses, there should be separate listings for each shop in his SA, if he completed them correctly! If not use the VAT returns and P60's, there is no real need to go through reams of "Z"s as well.

If he has been doing the VAT without the aid of proper accounting software just check that the returns include all invoices inc' the rent/rates etc. These are two big ones you don't want to "miss".

 

[BBsas]

Thanks Dr P.
You've been a real help and I am starting to get to grips with the boundaries of my task.
I will certainly keep this thread posted about progress.
Anyone else who has been in a similar position and remembers details of how they overcame the information gap most welcomed still, thanks in advance.