Financial Statement Analysis in Mergers and Acquisitions
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Financial Statement Analysis in Mergers and Acquisitions
Howard E. Johnson, MBA, CA, CMA, CBV, CPA, CFA
Campbell Valuation Partners Limited
Overview
Financial statement analysis is fundamental to a corporate acquirer’s assessment of an acquisition or merger candidate. As part of its due diligence investigation, a corporate acquirer typically analyzes the current and prospective financial statements of a target company. This 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.
This paper will address the practical applications of financial statement analysis typically performed by corporate acquirers in open market valuation and pricing exercises. This paper is not intended to be an all-inclusive discussion, and some of the items discussed may not be applicable in a given situation. Every open market transaction is unique, and judgment is required to determine the appropriate nature and level of financial statement analysis that should be undertaken in each case.
Determining value and price
The principal determinants of the value of the shares (or underlying net assets) of a target company in an open market transaction are:
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• the quantum and timing of prospective (after-tax) discretionary cash flows that will be generated. This typically includes discretionary cash flows to be generated by the target company from its operations on a ‘stand-alone’ basis as well as discretionary cash flows that a buyer anticipates will arise in the form of post-acquisition synergies;
• the acquirer’s required rate of return given its perceived level of risk of achieving said discretionary cash flows and its perception of the target company’s ‘strategic importance’; • redundant (or non-operating) assets that are acquired as part of the transaction; and
• the amount of interest-bearing debt that is assumed
Financial Statement Analysis in Mergers and Acquisitions
Howard E. Johnson, MBA, CA, CMA, CBV, CPA, CFA
Campbell Valuation Partners Limited
Overview
Financial statement analysis is fundamental to a corporate acquirer’s assessment of an acquisition or merger candidate. As part of its due diligence investigation, a corporate acquirer typically analyzes the current and prospective financial statements of a target company. This 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.
This paper will address the practical applications of financial statement analysis typically performed by corporate acquirers in open market valuation and pricing exercises. This paper is not intended to be an all-inclusive discussion, and some of the items discussed may not be applicable in a given situation. Every open market transaction is unique, and judgment is required to determine the appropriate nature and level of financial statement analysis that should be undertaken in each case.
Determining value and price
The principal determinants of the value of the shares (or underlying net assets) of a target company in an open market transaction are:
- 2 -
• the quantum and timing of prospective (after-tax) discretionary cash flows that will be generated. This typically includes discretionary cash flows to be generated by the target company from its operations on a ‘stand-alone’ basis as well as discretionary cash flows that a buyer anticipates will arise in the form of post-acquisition synergies;
• the acquirer’s required rate of return given its perceived level of risk of achieving said discretionary cash flows and its perception of the target company’s ‘strategic importance’; • redundant (or non-operating) assets that are acquired as part of the transaction; and
• the amount of interest-bearing debt that is assumed