Forcenturies, mergers, takeovers acquisitions have been in the businessworld. A company’s management should maximize shareholder value.However, they are unable to do this. Therefore, they may decide toconsider merging, acquiring or being acquired by another company ortake over. The decision is due to their need to develop a competitiveadvantage. An acquisition is a corporate action that often involves abigger firm buying most if not all of a smaller company`s ownershipstakes. The larger firm then assumes control of the target company`soperations and niche. It is an effective growth strategy that isapplied instead of expanding its market, stock, and operations.Acquisitions could be friendly or hostile and are paid in cash(Staff, 2016). In this line, conducting a financial analysis ofacquisitions plays a vital role in company’s performance,
ABCCompany is a big firm that intends to acquire a start-up business,Safeway, Inc., whose products are complimentary. Therefore, if ABCsucceeds in the acquisition, its operation base is going to increase,and its market share will be bigger than it was before. A financialstatement analysis is mandatory in carrying out the process ofdetermining the value of the target and thus the price of thetakeover. It is a part of due diligence investigation. The corporateacquirer analyzes both the prospective and current financialstatements of the target company. The net assets and value of sharesof the target company are examined.
A)FinancialStatements to Review to Determine the Financial Position of theSmaller Companies
Historicaland forecast financial statements, if available, are analyzed whenassessing the determinants of their equity value. It would involvegenerating an estimate prospective discretionary cash flow. Itrepresents the amount of money that is available to the capitalproviders, for example, shareholders and debt holders of thebusiness. The amount should be in a position to be withdrawn withoutaffecting the businesses` operations and ability to generate forecastoperating results (Howard, 2014).
B)Financial Ratios to use in Performing the
Whenanalyzing the historical financial statements of a target company,various financial ratios are also calculated. They are categorizedinto profitability, efficiency, liquidity, financial leverage as wellas operating ratios. These proportions provide the acquirer with aninsight into the performance of the target company. Ratio analysis ishowever affected by changes in accounting or management policies sothat they may not always be accurate and distort the analysis. Thescenarios below show where liquidity, solvency, and profitabilityratios would be used.
A Pension Fund Considering the Purchase of 20-year Bonds
Solvencyratios measure the company`s ability to meet its long-termliabilities (Peavler, 2016). The formula below is used to compute,and if it is above 20% then it is considered financially sound, andtherefore the probability of the pension fund defaulting on its debtobligations is minimal (Ready Ratios, 2016).
Solvencyratio = (After Tax Net Profit + Depreciation) / Total liabilities.
Thequick ratio, current ratio and current debts to inventory ratio aregood examples.
A Bank Contemplating a Short-term Loan
Liquidityratios include the quick ratio and the current ratio. Both of themmeasure the financial strength of the business in the short term.That is, whether the corporate acquirer will need to inject somecapital to support the target company’s operations. The bank wouldneed to analyze its liquidity ratio because bankruptcy analysts useit to determine a business`s going concern and credit-worthiness. Thefirm`s liquid assets are evaluated basing on their liabilities.
A Common Stockholder
Profitabilityratios show the proportion of revenues that are retained by thecompany at different levels. They also indicate the company’ssensitivity to income fluctuations. Examples include operating profitmargin and gross margin. A common stockholder would be interested inthe enterprise`s profitability ratios because income changes affectthe value of their shares.
C)Information to Review to decide if the Acquisition is Worth the RiskGiven That the Small Company has not been profitable
Itis essential to determine the target’s appropriate of return.However, the nature of the company’s operations, the industry itcompetes in, the acquirer’s cost of capital and the prevailingeconomic conditions must be considered. All things equal, the morepositive the prospective financial results, the higher the risk leveland the higher the rate of return required. In this case, the risksthat will be involved will be less because the products of ABCCompany and Safeway, Inc. are complementary. If the target companyhas not been profitable, that means that the rate of returnsanticipated is small and so is the risk involved in its acquisition.
D)IsAnalysis of Financial Statements directed at the Liquidity andProfitability of A Company?
Inany analysis, a reference to the liquidity and profitability of thebusiness is mandatory. Liquidity dwells on the ability of the firm tohave enough money to pay its bills, make unexpected big purchases orto have an emergency reserve at all times. On the other hand,profitability is all about ensuring utilization of cash in a way thatyields the highest returns (Vieira, 2010). These two concepts areinversely related. An efficient financial manager maintains a levelof operation whereby both risks and profits are optimized.
E)Difference between Vertical and Horizontal Analysis and How They AreUsed In Decision-making
Verticalanalysis of financial statements reports every amount as a percentageof another sum. If for example, income statement amounts are allpresented as a percentage of sales, then it is possible to comparethese rates with those of another company to see how they areperforming. However, horizontal analysis entails analyzing incomestatement amounts over the past financial years. It is important incomparing the performance of the business over time (Averkamp, 2016).Both concepts are important in decision-making, for example, in thiscase, the vertical analysis could be used to compare the performancesof ABC Company and Safeway, Inc. A decision is then made whether ornot it is advisable to acquire Safeway, Inc. Horizontal analysis canbe applied to see the trend of ABC. Is its performance increasing ordecreasing? It is then easier to assess whether it is a good idea tocontinue operating as usual or to acquire another company to expandits operations and market share.
F)Componentsto include in the Business Plan to Gain Attention of Loan Officer ata Financial Institution
Whenborrowing a loan from a financial institution, one of the mostimportant things to include in the business plan is the assets thatwill be used as collateral. That covers the bank or financialinstitution against risks such as default in repaying the loan. Otherthings that the loans officer is likely to look at include thebalance sheet to assess all the company’s assets, liabilities andcapital. The profit and loss account, as well as the statement ofcash flows, is also closely monitored to check historical balances.Hard evidence of the founders and managers who understand thebusiness well is also checked. It is information concerning companystrategy, products and services, history and location [ CITATION Tim13 l 1033 ].
Theabove discussion looks into acquisition as a strategy for businessesto improve their performance. However, to carry out an acquisition,some financial analysis must be conducted. Financial statements arereviewed and financial ratios used to determine if it is advisable ornot to go ahead with the acquisition. Risks are assessed as well.Vertical and horizontal analyses are some of the practical methods toensure the right decision concerning the acquisition is made.
Averkamp,H. (2016). What is the difference between vertical analysis andhorizontal analysis? Retrieved from Accounting Coach:http://www.accountingcoach.com/blog/vertical-analysis-horizontal-analysis
HowardE. Johnson, M. C. (2014). Financial Statement Analysis in Mergers andAcquisitions. Campbell Valuation Partners Limited.
Peavler,R. (2016). What Are Solvency Ratios and What Do They Measure?Retrieved from the balance:https://www.thebalance.com/what-are-solvency-ratios-and-what-do-they-measure-393211
ReadyRatios (2016). Retrieved from Solvency Ratios:http://www.accountingcoach.com/blog/vertical-analysis-horizontal-analysis
Staff,I. (2016). Mergers and Acquisitions: Understanding Takeovers.Retrieved from Investopedia:http://www.investopedia.com/articles/01/050901.asp
Vieira,R. S. (2010). The Relationship between Liquidity and Profitability.