The first rule of thumb that you must understand when analyzing the financials of any business that you are considering for purchase is that you must look at the financial records for at least the last five years. Minimum.

Anyone can cook the books and make it appear that they are showing a profit when in fact they could be drowning in a sea of debt and looking to cast their albatross off to an unsuspecting buyer.

The critical point here is to thoroughly investigate all records to determine the bottom line-are profits increasing or decreasing and by how much? In order to do this you will need to evaluate the financial records from several different perspectives. Do not simply rely on the information provided to you by the seller. Go in armed with an arsenal of your own questions and make sure you have cleared enough time in your schedule to complete a thorough investigation.

Always make sure that you ask to see the operating expenses. This will include the amounts of money going in as well as out of the business. Now, unless you are extremely familiar with the industry and know without a doubt how much these numbers should amount to; it’s always a good idea to compare these expenses to those of similar businesses.

A thorough financial review will include scrutiny of the following documents: past income statements, cash flow statements, balance sheets, articles of incorporation, past tax returns, statements regarding projected financials and any liabilities documentation. Also ask for documentation on any past or pending litigation as well as copies for all major contracts.

You should also take the time to have a thorough credit report run on the business. This step can help you to determine exactly where the company stands and also perform a check-up on the information that has been provided to you by the seller. If everything looks good on paper, but the credit report comes back with a seriously low score; this can be a strong indication that the information you have been given has been cooked.

Finally, don’t try to go it on your own. The most experienced and successful business people in the world will tell you that they rely on the advice of experienced accountants and attorneys when considering the purchase of a business.