Many financial documents need to be analyzed when conducting a valuation of a potential target. The analysis should focus on both the acquirer and the target. The acquirer needs to ascertain the value of the target to determine the proper offering price and whether the target meets the acquirer's financial standards. The target, in turn, needs to know what its company is worth. Presumably, this will tell the acquirer's management and board of directors whether the offer is in the stockholders' best interests. As part of this analysis, a series of key financial statements are examined. Each acquisition candidate has its own unique characteristics that make it different from other firms. These novel aspects may be discerned after considering information other than what is contained within the four corners of the standard financial statements. Therefore, the framework of financial statement analysis presented in this chapter is a basic model that may be followed in an analysis of a merger or an acquisition. It is a minimum and should be supplemented by additional analysis that is required because of the unique aspects of each transaction.
This chapter provides a review of financial statements and financial ratio analysis. The discussion of financial statement analysis is not meant to be comprehensive. Rather, it is designed to highlight some of the basic financial issues that need to be considered in business valuations for mergers and acquisitions. A more thorough and detailed discussion may be found in most good corporate finance textbooks. Suggested references are provided at the end of the chapter.
The three most basic financial statements are the balance sheet, the income statement, and the statement of cash flows. Publicly held companies prepare these statements on a quarterly and an annual basis. The quarterly statements are available in the 10Q quarterly reports that are filed with the Securities and Exchange Commission (SEC). The annual statements are available in the firm's 10K and Annual Report. These statements are available through many mediums. They may be readily downloaded on-line from various data sources such as the Edgar database.
The financial analysis of a merger or acquisition is one part of the overall due diligence process. Before a deal is completed, there is a legal and accounting due diligence process that is usually pursued. Attorneys and accountants usually run through a series of checklists of items that must be addressed or gathered. This process usually includes various informational items that must be verified before completing the deal. Many items are reviewed when doing due diligence. These items are far too numerous to be listed here but some of these items include leases, loan agreements, minutes of board of directors' meetings, employment contracts, other relevant contracts, and so forth. Various published acquisition checklists are available.1
1. Joseph Morris, Mergers and Acquisitions: Business Strategies for Accountants (New York:
John Wiley & Sons, 1995), pp. 36–121.