Terms Common to Purchase & Sale of Businesses

Though this is a long list of terms, it is by no means an exhaustive list of all terms.

The process of recording financial activities of a business, summarizing these activities, and analyzing the results.

Accounting Equation:
Assets = Liabilities + Owner’s Equity

Accounts Payable:
Amounts owed to vendors or other creditors for goods and services purchased on credit.

Accounts Receivable:
Amounts owed to the business by its customers. One measure of the health of a business is how fast customers pay off their accounts (Account Receivable Turnover). Less than 30 days is good, 30 to 60 days may be okay, and over 60 days could be a problem, but also depends on industries.

Accounting Cost:
The process of collecting materials, labor, and overhead costs and allocating them to products.

Accounting Period:
The period of time over which a business’s income and expense statement summarizes changes (usually based on a fiscal year).

Accrued Interest:
Accumulated unpaid interest to date on a note or mortgage.

Accrued Liabilities and Expenses:
Accumulated charges, such as interest or taxes, owed but not yet billed to the business, and therefore, not yet paid.

Accumulated Depreciation:
The total depreciation of an asset that has been charged as an expense to date.

Acid-test Ratio:
Also known as the “quick” ratio, it is the amount of current assets less the inventory, and divided by current liabilities; the standard is 1:1 and is a good snapshot indication of the health of the business. A business certainly needs enough current income to at least balance or offset current expenses or it could potentially get into trouble.

The relationship between a principal and an agent wherein the agent is authorized to represent the principal in certain transactions. It is a relationship in which responsibility is delegated from one party (the principal), for example the Seller or Buyer of a Business, to another, (the agent) such as the Broker or Intermediary.

A spreading out of costs over a period of time similar to depreciation. For example, it can be a reduction in a debt or fund by periodic payments covering interest and part of the principal over a period of time. It’s different from depreciation in that depreciation usually refers to physical things where amortization applies to things that expire such as mortgages and patents.

Amortization Schedule:
A tabular presentation of the reduction in value of something being amortized.

Assessed Valuation:
The taxable value of an asset as determined by a government source.

Everything a company owns or is due to it: current assets, such as cash, investments, money due, materials, and inventories; fixed assets, such as land, buildings (real estate), and machinery; and intangible assets, such as patents, and other goodwill.

Asset (Current Asset):
An asset which is either currently in the form of cash or is expected to be converted into cash within a short period, usually less than one year.

Asset (Fixed Asset):
Tangible physical property of relatively long life that generally is used in the production of goods and services, and not for resale purposes.

Asset (Intangible Asset):
Assets which normally have no physical form such as: skilled employees, patents, trade names and good standing in the community.

Asset (Net Book Value):
Original cost of the asset less accumulated depreciation.

Asset Purchase:
The process of buying a business’s specified assets rather than purchasing its common shares/stock.

Audited Financial Statements:
A business’s financial statement that has been prepared by a certified public accountant (CA, CGA, CPA(USA).) independent of the business owner in accordance with Generally Accepted Accounting Principles (GAAP). These statements show the business’s financial position and its results of operations.

Available Cash Flow:
Also referred as Free Cash Flow (CF), Seller Discretionary Cash Flow (SDCF), Seller Discretionary Earnings (SDE). The estimated actual cash available to a business owner after elimination of non-cash expenses (e.g. depreciation) and discretionary expenses (e.g. excess wages, donations, interest, etc.).

Balance Sheet:
A statement showing the nature and amount of a business’s assets, liabilities, and equity on a given date. In dollar amounts, the balance sheet shows what the business owned, what it owed, and the ownership interest in the company of its owners. It is a snap shot of the status of the business at a specific point in time.

Base Year:
A year chosen for comparison of numbers as the 100%, or “normal” year from which index numbers are computed.

Bonds Payable:
Long-term debt evidenced in writing by a contract and the issuance of certificates.

Book Value (Asset):
The accounting value of an asset shown on the Balance Sheet that is the original cost of the asset less accumulated depreciation. Keep in mind that this value may have little or no relationship to the real market value of the asset. Frequently, depreciation expenses are charged much faster than the actual decline in the asset’s market value.

Book Value (Business):
The book value of a business is determined from the financial records, by adding the current value of all assets (generally excluding such intangibles as goodwill), then deducting all debts and other liabilities. Book value of the business may have little or no significant relationship to actual market value due to depreciation and a lack of consideration of goodwill (intangibles).

Break-even Point:
This is the point at which a business’s net sales revenue equals its total costs. The calculation for a break-even point in the amount of sale units is:
B/E in sales volume = Total Fixed Cost/ Contribution Margin per unit
Contribution margin per unit = price/unit – marginal cost/unit

Bridge Loan:
Usually a very short term loan of funds to cover an unusual expense or fall-off in revenues. Sometimes bridge loans are used by buyers of businesses to get them over the initial 30 to 90 day transition period of the changeover in ownership of a business.

Structures owned by a firm and used in the operation of the business, part of fixed asset.

Business Plan:
A written plan detailing a business’s sales projections, expenses, marketing strategy, and objectives. A business plan is of great importance to anyone in the business, but of paramount importance to anyone buying or starting a business. You will never get there if you do not know where you are going!

Bulk Transfer:
A US Term. Article 6 of the Uniform Commercial Code regulates the bulk transfer through the sale or ownership change of a large portion (usually greater than 50%) of a business’s inventory, material, supplies, merchandise, and equipment. Requirements include the advance notification of creditors of the impending sale of a business and its assets listed above to prevent fraud. Provisions in each state are somewhat different so check your local statutes.

The amount that an individual, partner, or shareholder/stockholder has invested in a business.

The conversion of future income into a present value by use of a capitalization factor usually expressed as a percentage such as return on investment (ROI).

Capitalization of an asset:
The accounting listing of expenditure as a balance sheet asset rather than an expense.

Capitalization of a business:
The capital structure of a business consisting of the sum of the long term debt and the owner’s equity.

Capitalization of Net Profit:
A process to determine the present value of a business by applying a capitalization rate (ROI) to the projected net profit of a business.

Capitalization Rate:
A percentage number used to determine the present value of a stream of future earnings.

Cash Flow:
The difference between a business’s cash receipts and cash payments over a specific period of time.

Chattel Mortgage:
A financial claim on specifically identified personal property (non-real estate) to secure money owed on the property.

Closely Held Corporation:
An incorporated business whose corporate shares are held primarily by the principals in the business and are not publicly traded.

The process of legally completing the purchase and sale of a business.

Assets pledged by a borrower to secure a loan repayment.

The negotiated fee, usually a percentage of the purchase and sale price of the total business asset value, earned by a business broker for facilitating the sale of the business. Sometimes the value of the inventory and other non-capitalized assets are excluded from the calculation of the commission.

Common Shares/Stock:
Shares of ownership in a corporation.

An exclusive privilege of publication that grants legal protection to authors of original works both through common law and through registration with the U.S. Copyright Office.

A business unit created by charter, generally owned by one or more shareholders/stockholders who contribute the resources needed to start the business. The entity has continuous existence regardless of that of its owners and generally limits liability of owners to the amount invested in the organization. The entity ceases to exist only if dissolved according to proper legal process. It is easily transferred and has an unlimited life.

Cost of Goods Sold (COGS):
The amount paid for the merchandise that has been sold by a business, which is calculated as: COGS = Beginning inventory + Net purchases – Ending inventory.

One to whom a business owes a debt. One who has a financial interest in the firm’s assets.

Covenant Non-Compete:
An agreement given by the seller of a business to the business buyer to not compete in that or a similar business for a specified period of time, and within a specified geo- graphic area.

Current Assets:
Cash and other resources which are reasonably expected to be converted into cash or sold or consumed within one year or one operating cycle whichever is longer. Common current asset items include cash, marketable securities, accounts receivable, inventory and prepaid expenses.

Current Liabilities:
Debts which must usually be paid within one year. The payment normally requires the use of current assets.

Current Ratio:
The comparison of current assets to current liabilities which is the total current assets divided by total current liabilities. This ratio indicates a business’s ability to pay its current debts with its current assets. A good ratio is 2:1.

Debt Service:
This is the payment of principal and interest required on a debt (usually a loan or mortgage) over a specified period of time and interest rate.

Charges against earnings to write off the cost less salvage value, of an asset over its estimated useful life. It’s a book-keeping entry for accounting and tax purposes and does not represent cash outlay.

A distribution to its shareholders/stockholders of income earned by a corporation.

Draw (Owners):
Sometimes the owner of a small business (sole proprietorship or closely held corporation) will take income as a draw as opposed to a salary. The terms are essentially the same except that generally a salary means that all withholding taxes etc., are accounted for on the books of the business, whereas draw is straight cash to the owner who pays all tax obligations separately on a personal income tax return.

Due Diligence:
The process of investigation by a potential buyer into the business’s claimed financial and operational performance. This means reviewing actual CRA/IRS returns and/or financial statements, verifying inventory, verifying customers and sales, etc., in general, as a verification of any and all claims made by the business owner concerning the operation of the business to satisfy the buyer that all representations made are accurate. Additionally, it is also the legal process of ensuring the legal due diligence process such as clear titles of assets, pending litigations etc.

Earnest Money:
A US term. “Trust funds” would be the Canadian equivalent. The deposit provided by a buyer to a seller as part of an offer to purchase a business under certain conditions. The money represents a serious intention to negotiate on the part of the potential buyer.

This is the same as income and profit.

Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA):
The earnings of a business after eliminating non-cash expenses for depreciation and amortization, and after eliminating the discretionary expense of interest on debt and taxes. It is a measure of a business’s cash flow.

Employment Agreement:
This is an agreement whereby key employees agree to remain with the business for a specified period of time under certain conditions.

Assets which have long use lives, are used in the operation of a business, and are not intended for sale, part of fixed assets.

The financial interest of the owners in the firm’s assets.

Deductions from revenue or from gross profit on sales, depending upon the type of business activity, to determine net income. The cost of operating a business.

Expense Allocation:
The process of distributing an expense to a number of items or areas.

A process used by some businesses to improve their cash flow. A factoring company (usually a finance company or a bank) pays to a business a certain portion of the business’s trade debt and then is repaid as the trade debtors pay their account. This may be one more reason not to buy the accounts receivable; you do not have to find and clear any factoring liens.

Fictitious Name:
A name frequently used by sole proprietors or partnerships to provide a business name, other than those of the owners or partners, under which the business will operate. Also known as the trade name and the “doing business as” (DBA) name.

A position or person in a position of trust upon which certain reliance of facts may be placed.

The first in-first out method of inventory accounting that assumes that goods that enter the inventory first are the first to be sold.

Financial Statements:
Accounting reports, which include the balance sheet, income statement, statement of owner’s equity, statement of retained earnings, and statement of cash flow.

Fixed Assets:
Tangible physical property of relatively long life that generally is used in the production of goods and services, and not for resale purposes.

Fiscal Year:
The annual accounting period selected by a business to best correspond to its operations. A fiscal year can correspond to a normal calendar year or begin/end anywhere in-between, e.g.; the Federal government’s fiscal year begins
1 October and ends 30 September.

A form of business organization in which the franchiser (the primary company) provides to a franchisee (the local business) a market tested business package involving a product or service. The franchisee operates under the franchiser’s trade name and markets goods and/or services in accordance with a contractual agreement.

The collection of intangible assets represented in dollars by the difference between the total purchase price for the business and the net value of the tangible assets being purchased.

Government Accountant:
One who works for an agency of the government rather than for a firm or for himself.

Gross Margin:
The gross profit of the business stated as a percentage of net sales revenue.

Gross Profit (or Gross Income):
The net sales revenue of the business minus the direct cost of the products sold or services provided.

Income before Taxes:
Net sales minus cost of goods sold minus all expenses.

Income, Net:
Excess of total revenues over total expenses in a given period.

Income Statement:
A financial statement that summarizes a business’s revenues, expenses, and profits for a specific period of time, usually on a quarterly or annual basis.

Installment Sale
Mostly used in the US and similar to an earn out in Canada. It is the process of selling a business with the payments made over a period of time usually accompanied by a Promissory Note.

Intangible Asset:
A long-lived, non-physical asset, such as a patent, copyright, or trademark.

Finished goods being held for sale, and raw material and partly finished products that upon completion will be sold by the business.

Inventory Turnover:
Total cost of goods sold divided by the average value of inventory. Some businesses have very high inventory turnover and generally work on very low product markups. Other businesses have low turnover (such as furniture stores, jewelry stores, major equipment manufacturers) and consequently, usually have significantly higher markups.

Key Person Insurance:
Often called “key man” insurance, in which the business is paying for the life insurance for key persons (usually the owner) with the business backers (partners, spouse, investors, etc.) as the beneficiaries. This protects the investors from a catastrophic loss. This is fully deductible and is sometimes used by small business owners as a way to get “the taxperson” to underwrite part of their personal life insurance premiums. It is frequently an add-back in a reconstruction of business expenses.

Real estate owned by the firm and used in operating the business, part of fixed asset.

The agreement between parties for the rent of a particular asset (real estate, automobile, equipment, etc.).

Leasehold Improvements:
Usually refers to the improvements made by a lessee to a lessor’s property. Generally, leasehold improvements may be capitalized by a business and depreciated against income, but ownership reverts to the lessor upon completion of the lease.

The person or entity to which a lease of real or personal property is given.

The person or entity giving a lease for real or personal property.

All the claims against a business. Liabilities can include accounts and wages and salaries payable, accrued taxes payable, and fixed or long-term liabilities, such as mortgage bonds, debentures, and bank loans.

Liability, Current:
Obligations against a business that become due within a short time, usually one year.

A legal claim on certain assets that are used to secure a loan.

Liquid Assets:
Those assets easily convertible into cash including marketable securities, receivables, checking and savings accounts, and cash itself.

Liquidation Value:
The market value of a business’s tangible assets minus its liabilities under a forced sale.

A measure of the quality and adequacy of current assets to meet current obligations as they come due.

Long-term Liability:
Debts not yet due which usually have a maturity date more than a year in the future.

Loss, Net:
Excess of total expenses over total revenues in a given period.

The last-in-first-out method of inventory accounting that assumes goods that enter inventory last are the first to be sold.

A typical fixed asset, used to manufacture a product which have relatively long lives and are not intended for sale.

Manufacturing Firm:
A business unit which makes the product it sells.

Marketable Securities:
Temporary investments in readily marketable stocks and bonds.

The amount added to cost to arrive at the retail price for goods or services.

Merchandise Firm:
A business unit which acquires goods for resale at a profit.

Merchandise Inventory:
The value of the goods on hand which are intended to be sold in the regular course of operating the business.

Mortgage Payable:
A written promissory note of debt, usually secured by pledging a specific asset or assets.

Net Asset Value:
The value of an asset which is its original cost, less accumulated depreciation and liens.

Net Profit (Net Income or Net Earnings):
Money remaining after deducting all operating expenses including taxes; gross profit minus operating expenses.

Net Worth:
Same as Book Value of a business.

Note Payable:
A written promissory to pay to another a certain sum of money at a named future date.

Note Receivable:
A written promise by a customer to pay a certain sum of money to the company at a named future date.

Loss of value of a fixed asset arising because improved assets become available.

Operating Cash Flow:
This is cash flow directly generated by a business’s operations. It’s calculated by taking net income plus depreciation minus the increase in accounts receivable minus any increase in inventory plus any increase in accruals (money owned to the business as a result of operations). This is important to understand if you are going to underwrite a business expansion effort or anything else that requires cash flow generated by the business.

Operating Income:
This is earnings (profit) before deduction of interest payments and income taxes. This is a very important number for a buyer and seller of a business to know because it is the basis for the ability of the business to repay debt. In almost every case involving the purchase of a small business, the buyer will in some way finance the purchase (bank, SBA, seller, family, etc.).

Operating Statement:
Alternative title for income statement.

Method of allocating all non-labor costs (though some times partial labour factors can be a part of the overhead) to the various products manufactured or services performed.

One of multiple owners of an unincorporated business.

A legal business association of two or more individuals co-owning a business and sharing the profits and losses. Two most common types are general and limited partnerships.

An exclusive right granted to inventor or the inventor’s assignee to use a certain process or product.

Physical Inventory
Counting all merchandise on hand, usually at the end of an accounting period.

Prepaid Expenses:
Supplies and services paid for in advance and for which all benefits have not yet been received.

Present Value:
The value in current dollars of a future sum.

Private Accountant:
One who performs his service as an employee of a firm rather than as an independent contractor.

The same as earnings and income.

Profit (Gross):
Sales minus cost of goods sold.

Profit and Loss Statement:
Alternative title for Income Statement.

Pro Forma:
A set of projected financial statements for a business which usually includes: Balance Sheet, Income Statements, and Cash Flow Statements. Generally, in a purchase and sale of a business, the seller prepares an optimistic Pro Forma Statement. The buyer should ensure that a realistic Pro Forma is used as part of the Business Plan for the newly acquired business.

Promissory Note:
A written promise to pay a sum of money at a specified future date in accordance with a pre-determined interest rate and payment schedule. Normally written from the buyer to the seller for a period of 5–10 years.

The only owner of an unincorporated business who is responsible for its operation and liabilities.

Spread equally over a period of time.

Public Accountant:
One who offers his professional services to the public for a fee.

Quick Ratio:
The ratio of liquid assets to current liabilities. This is also known as the “acid test” ratio. If an operating business routinely has fewer liquid assets than its current liabilities, problems are sure to follow.

Sometimes used interchangeably with sales and revenue.

Residual Value:
Estimated scrap or resale value of a tangible asset.

Return on Investment (ROI):
The annual income that an investment earns. Usually expressed as a percentage relative to the purchase and sale of a business.

The gross income received as a result of business operations.

The revenue earned from selling a firm’s merchandise to its customers.

Service Business Firm:
A business unit that generates revenue by performing a service as opposed to making or selling a product.

SIC Code:
Standard Industrial Classification Code assigned to businesses within an industrial category as determined by the U.S. Department of Commerce.

Simple Interest:
Interest on principal only, as compared to compound interest which is interest on both principal and accumulated interest.

Sole Proprietorship:
A form of business owned by one person who is responsible for the entire business operations and liabilities.

Ability of a business to meet interest cost and repayment schedules associated with long-term obligations.

Statement of Changes in Financial Position:
A financial statement that shows the flow of funds through a business.

Statement of Financial Condition:
Alternative title for balance sheet.

Statement of Financial Position:
Alternative title for balance sheet.

Statement of Operations:
Alternative title for income statement.

Statement of Owner’s Equity:
A financial statement that shows the changes that have taken place in the proprietor’s capital during a certain period of time.

Subsidiary Operations:
The operations of a business that are separately accounted for in the financial statements. Usually used for business operations as separate profit centers. A daughter company, mother company or related company.

Sweat equity:
A loose term generally used to mean the value of a business over and above its net asset value. Also known as goodwill that the owner of the company has put into the business.

The owners of a corporation, who hold shares/stock certificates as evidence of ownership. Often used in publicly traded companies.

Tangible Asset:
A physical asset such as a plant asset, equipment, and machinery etc.

Taxable Income:
Income on which income tax is computed; gross income minus both exemptions and personal deductions.

A legal right given by a Patent and Trademark Office for a name or symbol, granting its creator exclusive use.

Trade Name:
The business name under which a business operates. Also known as DBA name (doing business as …)

An exchange of values which will cause changes in a firm’s assets, liabilities, or owners’ equity, or in more than one of these.

Trust Funds/Deposit:
The deposit provided by a buyer to a seller as part of an offer to purchase a business under certain conditions. The money represents a serious intention to negotiate on the part of the potential buyer.

The rate at which an asset is replaced within a given time period; usually refers to annual rate of replacement of stock such as “inventory turnover” or payment of accounts receivable turnover.

Venture Capitalist:
A person or entity with the purpose of investing funds in business startups, expansions, acquisitions, new products, etc., generally for the purpose of realizing financial returns through ownership of equity positions in the business.

Working Capital:
Readily convertible capital required in a business to permit the regular carrying forward of operations free from financial encumbrances. In accounting terms, this is the excess of current assets over current liabilities as at a specific point in time.

Write Down:
To reduce the book value of an asset to its current market value where the asset has actually decreased in value faster than it has been depreciated.

The return on one’s investment, expressed as an annual rate of earnings and usually as a percentage based on cost.