The recent issue of Zachary Scott’s newsletter had an article titled, “Quality of Earnings.” The subtitle was, “It’s not how much money a company is making that counts; it’s how it makes its money.” (http://zacharyscott.com/pdf/Insight%20Fall%202010.pdf)
The article emphasized four areas:
• Business Practices
• Uncontrollable Factors
• Management Manipulation
• Changes in Economic Condition
Recent posts on this blog have discussed points one and three. In fact, my last post mentioned how the business practice of not replacing assets and having a poor culture are big reasons why businesses are perceived as not worth as much as the seller thinks.
Management manipulation (of the financial status) does not mean there is dishonesty or a lack of integrity. It often is that the business is a conduit for lifestyle (personal) expenses for the owner, family members and some close employees. It may also mean there are off balance sheet items that are significant or that the company is managed for short-term profit not long-term stability.
The bottom line, pay attention to things mentioned above and in the Zachary Scott article.