What You Should Look for When Examining a Business
a) Insist on seeing income tax and sales tax returns for the last few years, not just financial statements. (You can be sure the owner will not have overstated his income on his tax returns!).
(b) Whatever you do, be careful when the seller tells you that he reports low income on his tax returns because he takes cash from the register without telling Uncle Sam. He may be telling the truth, but why should you expect that he's telling you the truth when he admits he's cheating on his taxes? Take this with a grain of salt. Many financial advisors and accountants will not advise their clients to pay for such "skim". Unfortunately, skimming does exist in the real world , especially in certain types of businesses like restaurants, deli's, Laundromats and dry cleaners and many buyers don't care. If you have in interest in buying a business of this nature, and you are willing to take the inherent risks that go along with it, you should absolutely verify that the income is what is being said to be by the seller. If you go this route, the best method of determining the extent of this "skim" is to mutually agree to review the systems, procedures, and books and records of the seller during an observation" or "trial" period. If the seller is not willing to show you just how he skims, or, if you are not reasonably satisfied that skim exists, it probably doesn't. If this is the case, your purchase offer should discount anything that cannot be proven to you by the seller. If you are not satisfied, then just say "thanks but no thanks" and walk away. There will be plenty of other deals and opportunities down the road.
c) As with most small businesses, the objective is to minimize the income tax effect on profit, consequently, many owners will write off everything they can, therefore, you may have to spend some time with the owner reconstructing the income and expenses taking into consideration all of the perks.
He may be writing off an unnecessary automobile, his wife may be on the payroll without actually performing services, and he may be providing health and life insurance benefits for himself and his family. This is all part of the cash flow of the business. Don't be afraid to ask.