How To Analyze A $1,000,000 Business Deal (To Avoid Getting SCAMMED)
Updated on July 18, 2025
Transcript
What if I told you you could analyze a million dollar business deal using nothing more than elementary school math? Now, most people think you need an MBA or years of accounting experience to understand whether a business is worth buying or not. But the most successful business buyers I personally know—and we have helped sell over 2,400 businesses at this point—use incredibly simple rules that pretty much anyone can understand when it comes to acquiring a business.
I'm about to show you five financial red flags that can instantly tell you whether you should walk away or you should lean in and acquire that business. So here's the big picture and what most people get wrong when it comes to financial analysis: They think it's all about being perfect with numbers, when it's not. No business is perfect with their numbers. No matter how much an accountant goes over and goes through everything, there are always mistakes, always a little errors here and there, right?
So, financial analysis when it comes to buying a business is really about spotting patterns and asking the right kind of questions. Think of it like buying a used car. You don't need to be a mechanic to know that strange noises coming from the engine are probably not a good sign. And you should probably check the mileage on the car, right? This is just common sense stuff.
So the goal when it comes to analyzing a business you want to buy isn't about becoming an accountant who knows all the tools of the trade. Rather, the goal is to quickly identify whether this business will make you money or lose you money.
**Rule Number One: The Three Year Minimum**
The three year minimum means any business worth buying should show you at least three years of financial history. Not two years, not 18 months—three full years, minimum. Are there caveats to this? Absolutely. We have sold businesses that don't have this three year minimum. Some haven't even been alive for a year yet. So we have definitely broken this rule. But if you want to buy a business where you have the most clarity and the least amount of risk, then three years should be your minimum for the financial documentation of the company.
Why is this? Because businesses have good months and bad months. Even really solid, really great businesses have a bad, no good time every now and then. So, one good year could be a fluke. Two good years might just be luck. Now, if you have three good years, now a consistent real pattern is showing. And what are we looking for? Patterns. We're looking for the right patterns.
So red flag number one is: If the seller can't or won't show you three years' worth of records, you should walk away immediately—no exceptions. Now, for sellers out there who have no records even though you have a good business, get in an accounting system. I have a video that's probably going live here shortly all about that. So if that's you, you should watch that video, subscribe, and you'll see it.
While three years is my personal minimum, it is even better if you actually go a little bit longer—to five years. Traditionally, the way this financial history is broken down is you'll see it done year by year, broken down yearly, and then the last trailing 12 months of the business is going to be broken down into monthly chunks. That will give you a deeper picture of what is going on recently with the business.
**Rule Number Two: Customer Concentration**
Revenue sounds impressive, but what matters is how stable is that revenue? Because I am willing to buy most things, but if your revenue isn't stable, then I'm going to give you a much worse offer than if your revenue is stable. And how do you tell that with a business? This magic number: no single customer should represent more than 20% of the total revenue of the business.
If one customer makes up 30, 40, or 50% of the business, you're not buying a business. You're buying a very risky job. Some buyers are okay as long as nothing hits 40% concentration, but if you want the least possible risk in my view, then I'd recommend your number to really be closer to that 20%. Customer concentration can be a real business killer. You want to see that revenue spread across many, many customers, ideally with nothing being dependent on just a few big whales in the system who could cancel at any time, even with a contract. And if they do, it can mean absolute scorched earth when it comes to the valuation of the business you just spent maybe millions of dollars on acquiring. We don't want that.
So, red flag: no customer making up over 20% of their revenue. You want a good diversified base of customers, with a lot of different revenue streams coming in, so if you lose one client, it's totally fine.
**Rule Number Three: Owner Benefit Calculation**
If you forget all the fancy accounting terms, there's really only one number you need to truly understand, and that's called owner benefit. Owner benefit is what the current owner actually takes home after all the bills are paid—it's their SD, seller discretionary earnings.
Here's how you calculate it:
– Start with the net profit,
– Add back the owner's salary if they pay themselves,
– Add back any personal expenses they run through the business.
This will give you the real number of what the business can actually pay you to own it. Now, if you use a marketplace like us at Empire Flippers, you basically see this number already on the listing pages. The monthly net income takes into account all that. So whatever that net income is, that's how much income you have to pay yourself and to grow the business. And that is by far the most important number when it comes to acquiring a business, in my view.
A lot of people focus on revenue, but revenue is really not that important in a lot of ways. Revenue is kind of a vanity metric. I've been to so many cocktail parties where entrepreneurs are like, "Oh, making seven figures revenue." Like, great, what's the profit? And suddenly they don't want to tell you what the profit is because, you know, it might be a hundred grand—suddenly way less impressive. So we always want to get down to: what is the real number that this business can pay you to own it?
Your rule of thumb here is: the business should generate enough owner benefit to pay for itself in three to five years. So if you're buying a business worth $300,000, it should generate at least $60,000 to $100,000 in annual owner benefit. That's almost always a good rule of thumb: the business should be able to pay itself within three to five years.
The average valuation for most SMBs is going to be between 1 and 5.4x. If you're going above 4x, it means you're usually buying a much bigger business or a way more stable business, or it has a lot of unique good things going for it. But the vast majority of businesses will be 1 to 4x. If it's not declining, then it's probably going to be between 2.5 to 4x.
**Rule Number Four: Trend Analysis**
Big scary words here. Pull all those three years of financial records that you got and ask these simple questions to the seller:
– Is revenue generally going up? It doesn't have to be perfect. There could be lumpiness in there. But is the overall direction going the right way? We want it to be going upward. It doesn't have to be explosive growth; in fact, maybe it shouldn't be. Explosive growth comes with its own problems.
– Are expenses under control? If revenue is growing but profit is shrinking, that might be a red flag. It means they're spending more to make more. Why is that? Why are their costs going up as they're making more and more revenue?
Now, this is important if you're buying a company that's in one of these orphan zones, or it is in its moment of growth. Usually when businesses are in the moments of growth, their revenue starts exploding, but their profit does go down because they're hiring people, right? They're promoting people to managers, so more and more is going to payroll, which isn't necessarily a bad thing. But you need to look at this in the trend analysis of the financial records because if you spot that, that could be a really good sign where you can get the deal for less than what it would be worth in 12 months. Because once you acquire the business, all the work that the seller did—in terms of hiring, firing, growing systems—you get to catch the upside of that. So it's not necessarily a bad thing out of the gate if revenue is growing but profit is shrinking. Keep that in mind.
The next thing on this trend analysis is: Is it owner dependent? Is the whole business dependent on the owner? If profit drops dramatically whenever the owner takes time off, you're not really buying a business. You're buying yourself an expensive job. That can be okay to some people—maybe that's what they want—but I personally wouldn't. I wouldn't want to buy an expensive job; I would rather just go get a job that I am expensive for.
So, the best businesses run themselves. Look for businesses where the owner works on the business, not in the business. If you see things in the P&L (profit and loss statement) where revenue dipped and profit dipped and the seller's like, "Oh, I was in Barbados," or "I was taking a 30-day vacation," and those things always line up with those dips, that's a sign that the seller doesn't have systems in place where the business can run without them.
**Rule Number Five: Debt Analysis**
You need to understand there are two types of debt, right? There's good debt, such as equipment loans, inventory financing—things that help the business make money. Then there's bad debt—credit cards, personal loans that aren't being used for the business, maybe they're being used for something else. Anything with high interest rates, and at this point, variable interest rates. I'd much rather have fixed rates, though that's becoming less and less common.
Your simple rule here is: the total monthly debt payments should never exceed 30% of the monthly net profit. If they do, this business is potentially going to be living paycheck to paycheck if something bad happens, which—hey—even good businesses have bad days, right? So you have to be prepared for that.
Now, when it comes to debt, the majority of the time when you are looking to acquire a business, it is going to be done through what is known as an asset purchase agreement, or APA. What this means is you're not actually liable for any of the debt that the seller has. So if they have a massive loan on the business and you buy the business, that loan stays with the seller. It doesn't carry on to you. What the seller then has to do is take the money you pay them and go pay off that debt. That's how all that works.
But on the flip side, you might be using debt to go and acquire businesses. So if you are using debt to acquire the business, then the same thing I just said holds true: 30% of the monthly net profit is a general good rule of thumb in terms of your debt cap.
Now, some buyers who are way more confident and less fearful of risk might go up as high as 50% leverage. In fact, if you do full leverage with, say, an SBA loan, often from the outside, about half of your monthly net profit is going to go service the SBA loan. So this is not so uncommon that you would never do it. But just realize that the more debt you add to the business, the more vulnerable it becomes to market shifts and dynamics. Debt can be an amazing tool, but remember, the miracle of compound interest can be a curse just as much as a blessing.
**Common Mistakes Business Buyers Make**
Let's talk a little bit about some more common mistakes that you might make as a buyer.
*Mistake Number One: Getting Seduced by Potential*
It's very easy to find a business that you just think, "Wow, this is so amazing. This is the best thing I've ever seen." And the sellers will love you for it, because they will also tell you it's the best thing you've ever seen. And then you end up buying a business way overvalued because you got sold a dream. And this future fantasy never comes around because the seller overvalued it to begin with, and you overvalued it as well. We don't want to be seduced by potential.
You always want to buy a business based on what it has done today—not what it might do tomorrow. In fact, you should never pay for what it might do tomorrow, because that should be paying you. You're buying the business as it is today so you can benefit from that tomorrow. That's the whole point of buying the business. So don't get seduced by potential.
*Mistake Number Two: Ignoring Your Gut*
Your gut has more nerves in it than your brain—I believe that's true, some pop science for you. But if something is telling you, "Hey, something is wrong here. I don't know what it is. I can't put my finger on it, but something seems strange"—maybe the seller isn't answering direct questions, they seem a bit desperate, or they seem like they're kind of washing over something that they shouldn't be washing over. Your gut is often right in many, many situations. And buying a business can be a pretty big decision. So you should listen to your gut.
At the very least, if you're feeling like something is wrong, you should get a second trusted opinion to look over the documentation with you, so you have at least a second opinion to see if they also feel like something is wrong and they might actually know what's wrong, once you give them the documents.
*Mistake Number Three: Thinking You Need to Be Perfect*
This is probably the most important one to recognize when it comes to buying a business—whether you're analyzing finances or traffic or whatever. If you think, "I'm never going to buy something unless it's a perfect business," you will simply never buy a business. Or, you will naively buy a business, because there is no perfect business. Every business has its own fair share of problems and challenges and a bunch of systems held together by duct tape and glue. And that is the opportunity, right? That is the opportunity for you to come in and not make those systems held by duct tape and glue, but rather really cement them together and make it into a roaring machine. Every business, even ones that are doing really, really well, almost always have some kind of problem.
So there you go. The biggest risk isn't buying the wrong business. The biggest risk is never buying a business at all, because you think you need to be a financial expert. You really, really don't. Most business buyers that bought businesses from us are by no means financial gurus. They're very, very good at running the businesses and spotting patterns.
What you need is just the ability to look at a financial statement, know your way around it enough to be a little bit dangerous. But really what you need to do is just spot patterns and be able to ask the right questions.
So if that sounds cool to you and you want to start asking the right questions, come and register on our marketplace, empireflippers.com—register and start browsing some businesses for sale.
