Financial Statement Analysis in Mergers and Acquisitions

Financial statement analysis is used in estimating the ‘value’ of the shares or net assets of the target company, and in determining the price and terms of a transaction the acquirer is prepared to offer and accept.

The principal determinants of the value of the shares are: 1) after-tax cash flows that will be generated 2) the acquirer’s required rate of return 3) non-operating assets 4) amount of interest-bearing debt

Forecast financial statements are used for assessing each of the determinants of its equity value. In the terms of an open market transaction normally stipulate that adjustments to the agreed price may be required pending the results of the buyer’s final due diligence investigation.

Prospective Discretionary Cash Flow: represents the amount of money available to the providers of capital of a business that can be withdrawn without impairing the existing operations of the business, or its ability to generate its forecast operating results.

The amount of weight afforded to historical operating results depends on whether and to what extent they are believed to represent what the target company prospectively is capable of generating on a stand-alone basis.

The financial ratios are used to make an analysis of the historical financial statements of an acquisition target such as: profitability, efficiency, liquidity, financial leverage, and operating ratios.

The identification of unusual or non-recurring items are not indicative of prospective operating results. They are part of revenues or expenses from ongoing operations. The analysis of historical financial statements should not be limited to annual results. Quarterly and monthly results provide insight as to seasonality and interim performance.

Historical cash flow statements provide an indication as to the capital investment