Small business entrepreneurship case study analysis and discussion

¶ … buyer want to see. One of the most important things about financial statements is that they are only useful if you know what the inputs are. Thus, financial statements must be completed according to a specific format in order to be understood. In the U.S., that format is the generally accepted accounting principles (GAAP), which are the basis for the construction of financial statements (AICPA, 2013). So while Sly is telling the truth, this is not relevant. For the income statement to be useful, it needs to be produced according to GAAP. This allows the reader to understand the information contained within. The buyer can decide what information is relevant and what is not. The income statement Sly provided is more of an attempted Statement of Cash Flows, whereas under GAAP both would have been produced to a common standard. Gwen needs to ignore this income statement and has the right to receive one based on GAAP. The Schedule C. is much more useful at this point, but it is better that she has all the GAAP financial statements in her possession in order to properly value the company

2.

Without having accurate financial information, it is tough to say what the purchase price should be. The Schedule C. profit is $10,000, and the company had been losing money in years previous. The valuation is probably somewhere south of the asking price. To value a company requires a few things Gwen does not have yet. She needs the net income, the cost structure of the company, the fixed assets, the cash flows and it would help to have a sense of what other, similar companies make. Furthermore, she should talk to the customers and make sure that they would be interested in this product made by a different person. If their willingness to buy is related to a relationship with the present owner, that has to be discounted. So there are a lot of things that Gwen does not yet know that relate to the question of business valuation.

If it is assumed that this business made a profit of $10,000 last year, and that this 10% financing rate offered is at least somewhat indicative of the discount rate, the perpetual value of the firm is around $100,000. The valuation of $250,000 is obviously pricing in a lot of growth that the current ownership had nothing to do with. It also prices in a high valuation on the equipment -- this might be pro-equipment but if it fits in a kitchen it is not worth more than a few thousand. So by cash flow, income or asset value, the asking price for this business appears to be way too high (Zwilling, 2009).

3.

Gwen is missing a lot of information that she needs, most of it related to valuation. She needs to know exactly what comes with this purchase. Yes, she will receive fixed assets but the value of the business does not lie in the pots and pans. The value of the business lies in the brand, the relationships with the vendors and with the recipe. She needs to know what sort of transition period will be given to help bring her up to speed with the customers, and how much of this IP comes with the business. She also needs to have GAAP financial statements that she can analyze.