Buying an existing business can be a great investment — but before making a decision, you must evaluate its financial health, profitability, debt position and ability to generate cash.
A business with high sales is not necessarily a profitable business. The real question is: How much profit does it generate, how much cash does it earn, and what risks are you taking over?
Here are the key financial ratios every buyer should analyse before acquiring a running business.
1. Profitability Ratios
These ratios help you understand how much profit a business earns from its sales and investment.
1. Gross Profit Margin (GPM)
Gross ProfitNet Sales×100\frac{\text{Gross Profit}}{\text{Net Sales}}\times100Net SalesGross Profit×100
Measures the profit remaining after deducting the direct cost of goods sold.
Example: Sales ₹1 crore and gross profit ₹30 lakh = 30% GPM.
A higher or improving margin generally indicates better pricing power or cost control.
2. Net Profit Margin (NPM)
Net ProfitNet Sales×100\frac{\text{Net Profit}}{\text{Net Sales}}\times100Net SalesNet Profit×100
Shows how much profit the business retains after expenses, interest and taxes.
Example: Net profit ₹8 lakh on sales of ₹1 crore = 8% NPM.
A low or declining margin may indicate rising costs, excessive overheads or weak pricing.
3. EBITDA Margin
EBITDANet Sales×100\frac{\text{EBITDA}}{\text{Net Sales}}\times100Net SalesEBITDA×100
Measures operating profitability before interest, taxes, depreciation and amortisation.
Example: EBITDA ₹15 lakh on sales of ₹1 crore = 15% EBITDA margin.
Useful for comparing businesses with different financing and depreciation structures.
2. Liquidity Ratios
These ratios indicate whether the business can pay its short-term obligations.
4. Current Ratio
Current AssetsCurrent Liabilities\frac{\text{Current Assets}}{\text{Current Liabilities}}Current LiabilitiesCurrent Assets
Measures the ability to meet short-term liabilities using short-term assets.
Example: Current assets ₹40 lakh and current liabilities ₹20 lakh = 2:1.
A ratio around 1.5–2 may be comfortable in some businesses, but the ideal level depends on the industry and the quality of current assets.
5. Quick Ratio (Acid-Test Ratio)
Current Assets−Inventory−PrepaymentsCurrent Liabilities\frac{\text{Current Assets}-\text{Inventory}-\text{Prepayments}}{\text{Current Liabilities}}Current LiabilitiesCurrent Assets−Inventory−Prepayments
Tests whether the business can meet short-term liabilities without relying on selling inventory.
Example: Quick assets ₹15 lakh and current liabilities ₹20 lakh = 0.75:1.
A low ratio may indicate dependence on inventory sales or timely customer collections.
3. Debt and Solvency Ratios
These ratios help identify financial risk and the burden of existing borrowings.
6. Debt-to-Equity Ratio
Total DebtShareholders’ Equity\frac{\text{Total Debt}}{\text{Shareholders’ Equity}}Shareholders’ EquityTotal Debt
Shows how much debt the business uses compared with its own capital.
Example: Debt ₹30 lakh and equity ₹60 lakh = 0.5:1.
A high ratio can mean greater financial risk, especially when profits are unstable. Also check whether the seller’s loans will be repaid or transferred as part of the deal.
7. Interest Coverage Ratio
EBITInterest Expense\frac{\text{EBIT}}{\text{Interest Expense}}Interest ExpenseEBIT
Measures how comfortably operating profit covers interest costs.
Example: EBIT ₹12 lakh and annual interest ₹3 lakh = 4 times.
A low ratio suggests that even a small fall in earnings could make debt servicing difficult.
4. Efficiency and Working Capital Ratios
These ratios show how efficiently the business uses its inventory, assets and credit facilities.
8. Inventory Turnover Ratio
Cost of Goods SoldAverage Inventory\frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}Average InventoryCost of Goods Sold
Measures how many times inventory is sold and replenished during a period.
Example: Annual cost of goods sold ₹60 lakh and average inventory ₹10 lakh = 6 times.
A low ratio may indicate slow-moving, obsolete or excess stock. A very high ratio may indicate insufficient inventory.
9. Debtors Turnover / Collection Period
Collection Days=Average Trade ReceivablesCredit Sales×365\text{Collection Days}=\frac{\text{Average Trade Receivables}}{\text{Credit Sales}}\times365Collection Days=Credit SalesAverage Trade Receivables×365
Indicates how long the business takes to collect money from customers.
Example: Average receivables ₹10 lakh and annual credit sales ₹1 crore = approximately 36.5 days.
Longer collection periods can create cash-flow problems and increase the risk of bad debts.
10. Working Capital Ratio / Working Capital Requirement
Working Capital=Current Assets−Current Liabilities\text{Working Capital}=\text{Current Assets}-\text{Current Liabilities}Working Capital=Current Assets−Current Liabilities
Shows the funds required to run daily operations.
Example: Current assets ₹35 lakh less current liabilities ₹20 lakh = ₹15 lakh working capital.
Before buying, determine how much additional money you must invest in stock, customer credit and operating expenses.
5. Return on Investment Ratios
These are among the most important ratios for a person planning to purchase an existing business.
11. Return on Capital Employed (ROCE)
EBITCapital Employed×100\frac{\text{EBIT}}{\text{Capital Employed}}\times100Capital EmployedEBIT×100
Measures the operating return generated by the capital invested in the business.
Example: EBIT ₹20 lakh and capital employed ₹1 crore = 20% ROCE.
A higher ROCE relative to comparable businesses generally indicates better capital efficiency.
12. Return on Investment (ROI)
Annual Net ReturnTotal Investment×100\frac{\text{Annual Net Return}}{\text{Total Investment}}\times100Total InvestmentAnnual Net Return×100
Estimates the annual return earned on the money invested in acquiring the business.
Example: Total investment ₹50 lakh and annual net return ₹10 lakh = 20% ROI.
Use sustainable earnings after allowing for a fair salary for your own work, maintenance costs and other necessary expenses.
6. Cash Flow and Repayment Ratios
A business may report profits but still struggle to pay its bills. Therefore, always analyse actual cash generation.
13. Operating Cash Flow Ratio
Operating Cash FlowCurrent Liabilities\frac{\text{Operating Cash Flow}}{\text{Current Liabilities}}Current LiabilitiesOperating Cash Flow
Measures the ability to meet short-term obligations using cash generated from operations.
Example: Operating cash flow ₹12 lakh and current liabilities ₹20 lakh = 0.60.
Compare this over multiple years to identify whether reported profits are converting into cash.
14. Debt Service Coverage Ratio (DSCR)
Cash Available for Debt ServicePrincipal + Interest Due\frac{\text{Cash Available for Debt Service}}{\text{Principal + Interest Due}}Principal + Interest DueCash Available for Debt Service
Measures the ability to repay loan instalments and interest.
Example: Cash available ₹18 lakh and annual principal plus interest ₹12 lakh = 1.5 times DSCR.
A higher DSCR provides a greater repayment cushion. The precise calculation and acceptable threshold depend on the lender and loan terms.
7. Business Valuation Ratios
Even a profitable business may be a poor investment if you pay too much for it.
15. Price-to-Earnings (P/E) Ratio
Purchase Price of EquityAnnual Net Profit\frac{\text{Purchase Price of Equity}}{\text{Annual Net Profit}}Annual Net ProfitPurchase Price of Equity
Shows how many years of current annual earnings the purchase price represents, before considering growth or other factors.
Example: Equity purchase price ₹60 lakh and annual net profit ₹10 lakh = 6 times P/E.
Compare with similar businesses, considering their growth, risks and earnings quality.
16. Enterprise Value / EBITDA
Enterprise ValueEBITDA\frac{\text{Enterprise Value}}{\text{EBITDA}}EBITDAEnterprise Value
Compares the total business value, including net debt, with operating earnings.
Example: Enterprise value ₹1.2 crore and EBITDA ₹20 lakh = 6 times EV/EBITDA.
This is useful for comparing businesses with different debt and cash positions. Ensure the purchase price and EBITDA are calculated consistently.
8. Revenue Growth Ratio
17. Sales Growth Rate
Current Year Sales−Previous Year SalesPrevious Year Sales×100\frac{\text{Current Year Sales}-\text{Previous Year Sales}}{\text{Previous Year Sales}}\times100Previous Year SalesCurrent Year Sales−Previous Year Sales×100
This measures whether the business is expanding or declining.
Example: Sales increased from ₹80 lakh to ₹1 crore.
Sales growth = 25%.
However, rising sales with declining margins, increasing debtors or falling cash flow can be a warning sign.
Practical example: Should you buy this business?
Suppose a seller offers a running business for ₹50 lakh.
Business acquisition calculator
Enter the figures to estimate the business’s returns and basic financial position.
Purchase price (₹ lakh)
Annual net profit (₹ lakh)
Annual sales (₹ lakh)
Debt assumed (₹ lakh)
Annual operating cash flow (₹ lakh)
Estimated annual ROI
20.0%
Price / net profit
5.0×
Net profit margin
10.0%
Cash flow / assumed debt
0.80×
Illustrative calculations only. ROI uses purchase price as the investment base; the cash-flow/debt figure is not DSCR. Actual returns should include acquisition costs, working capital, taxes, maintenance investment and financing terms.
Final checklist before buying a running business
- Analyse at least 3 years of audited financial statements and ITRs.
- Verify GST returns, sales invoices and bank statements against reported turnover.
- Check gross profit, net profit and EBITDA trends.
- Review outstanding loans, statutory dues, creditors and contingent liabilities.
- Verify inventory quality, debtor recoverability and working capital requirements.
- Calculate ROI using the total acquisition cost, not just the seller’s asking price.
- Examine customer concentration, lease terms, licences and dependence on the existing owner.
- Check whether the business generates sufficient cash to fund operations and repay debt.
BizzXchange takeaway: Never buy a business only because its turnover is high or the seller claims it is profitable. Analyse its profitability, cash flow, debt, working capital and valuation before deciding the right purchase price.
