CHAPTER 11 Using Financial Information to Gauge Enduring Profitability

Question 1

What financial measure is used as an initial test for profitability in small business acquisitions?

Answer 1

EBITDA margin (Earnings Before Interest, Taxes, Depreciation, and Amortization divided by revenue).

Question 2

Why is EBITDA margin a good initial test for enduring profitability?

Answer 2

It shows the business is profitable and potentially has competitive advantages that prevent margin erosion.

Question 3

What are the target EBITDA margin thresholds for different business types?

Answer 3

At least 20% for manufacturing and service businesses; 15% for wholesalers and distributors.

Question 4

What does a high EBITDA margin suggest about a business?

Answer 4

It may have qualities that protect it from competition and customer churn.

Question 5

What does churn rate measure?

Answer 5

The percentage of customers who stop buying from the business from one year to the next.

Question 6

What is an ideal churn rate when evaluating a small business?

Answer 6

25% or less.

Question 7

How can you calculate churn rate from customer lists?

Answer 7

By counting how many customer names drop off the list from one year to the next.

Question 8

What is customer concentration, and why is it important?

Answer 8

It’s the percentage of revenue from top customers; high concentration is risky for long-term profitability.

Question 9

Why is revenue growth from new customers potentially concerning?

Answer 9

It may indicate customers are not sticky, or that growth is not sustainable if based on poaching competitors’ clients.

Question 10

What are preferred sources of revenue growth in enduringly profitable businesses?

Answer 10

Market growth, price increases, or new product introductions.

Question 11

Why should you examine a business’s revenue during a recession like 2008–2009?

Answer 11

To check if it is cyclical and assess how it handles economic downturns— a drop of 30%+ in EBITDA is a red flag.

Question 12

What are the five key quantitative filters for assessing enduring profitability?

Answer 12

1. High EBITDA margin
2. Recurring customers
3. Fragmented customer and supplier base
4. Proper sources of revenue growth
5. Non-cyclical, steady sales

Question 13

What made Zeswitz Music an attractive acquisition candidate?

Answer 13

45% EBITDA margin, recurring school rental revenue, low concentration risk, stable customer base, and resilience during the recession.