Mergers and acquisitions, obviously better known as M&A transactions, are all about numbers. The due diligence process involves scouring volumes of documents, the vast majority of which relate to a company’s financial matters. For this reason, it is imperative for businesses to maintain accurate and comprehensive company records. In the event that a company decides to sell, whether all or a portion of its business, there will be a host of numbers requested from interested parties in order for them to get a sense of the selling company’s financial standing. Here are several of the key financial metrics with which potential sellers must become familiar:
Earnings Per Share (EPS)
Broadly speaking, EPS is simply a company’s net income divided by the number of outstanding shares. Although this seems like a fairly simple mathematical equation, different companies may have a different idea as to what figures are included under the earnings umbrella. Even though companies may have some wiggle room here and can be a bit creative for their own benefit, the reported EPS is the safest bet, as this is the one that accords with Generally Accepted Accounting Principles, or GAAP. Because of its acceptance in the accounting world, the reported EPS is the one that is also used for filings with the Securities and Exchange Commission. Thus, a company must regularly calculate and track its EPS, but especially when preparing to sell.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
This may seem similar to EPS since it is based on a company’s earnings, but it provides more information as to a company’s actual net income, and thus is a good representation of its general profitability. The portion that is essentially added back, the ITDA part, removes the effects of accounting, financing, and/or taxes that are not entirely indicative of a company’s actual financial performance. Although this particular calculation is not in accord with GAAP, it does allow for potential buyers to better compare the profitability of companies. This is because it excludes the impact that things like tax rules may have that can in a sense dilute a company’s apparent profitability. Therefore, sellers definitely want to calculate and be able to present their EBITDA to interested buyers.
Valuation is hands down the most important figure discussed during M&A negotiations and due diligence. Granted, earnings say a lot about a company’s potential value, but valuation takes into account far more than revenue or cash on hand. In many cases, valuation is derived on the basis of financial performance and also includes projections and forecasts in light of historical data. And, it can even include the value of intangible assets, particularly unique intellectual property. There are different approaches to coming up with a company’s valuation, such as market-based, asset-based, or income-based, so a company must evaluate which approach makes the most sense based on the nature of its business. Ultimately, coming up with accurate valuation and having the evidence to support it is crucial during M&A.