Financial modeling is a decision-making instrument based on a company’s earnings and expenses. Analysts and other professionals use such data to forecast how the company is likely to perform in the future. Though it’s mostly used for predicting stock performance, it has also become a common tool for mergers and acquisitions as well.
The M&A market is on a steep upward trend worldwide. Last year, the volume of deals above USD 1 billion increased by 17%. However, creating effective models is very difficult, which is why companies resort to professional financial modeling services like Acquinoxadvisors. Here’s how such models are reshaping the mergers and acquisitions market.
How Financial Modeling Works
The financial modeling services by AcquinoxAdvisors go much beyond putting numbers on a spreadsheet. Thanks to technologies like AI and machine learning, much larger amounts of data can be crunched much more effectively, returning insights that the human eye could easily miss.
Better still, these technologies combined with big data can also provide predictive analysis regarding a business’ health. There are systems to automate data collection in real-time, providing interactive dashboards where the information can be seen much more clearly. The benefits of financial modeling services for investors are rather obvious, but they are also perfectly applicable to M&A.
M&A models focus not only on the target’s financial health but also on how both companies combined will perform in the future. This means looking for synergies between both parties and making sure that the final deal will be profitable for everyone involved. More importantly, M&A models help set the acquisition’s debt structure and make cost-saving adjustments.
Main Aspects
When it comes to mergers and acquisitions, financial modeling services focus on very specific criteria. Indeed, several models are usually created to simulate different variables, considering how much money in cash and shares will be spent on the operation, integration costs, and any cost-saving opportunities that might be available.
A financial forecasting & modeling expert can make projections based on information provided by the target. These include balance sheets, cash flow statements, income statements, and financial planning. The valuation process involves estimations of cash flow and the amount that still needs to be invested to reach its goals. Only then it’s possible to arrive at a correct valuation of the target business.
It’s also necessary to compare the balance sheet items of the target and acquiring companies. Once both sheets are combined, assumptions regarding PPA (Purchase Price Allocation) and goodwill calculations can be made. Deal accretion or dilution is the final step of the process when the total number of shares and net income arrive at EPS (Pro Forma Earnings per Share). If EPS decreases after the combination, it means it was a dilutive deal.
High-Value Benefits
Mergers and acquisitions are incredibly complicated processes, and miscalculating any step can lead to severe losses and even bankruptcy. Mathematical models and algorithms can provide a thorough understanding of the target company’s financial statements, ensuring that the deal will be profitable. They’re also indispensable tools for elaborating efficient financial strategies for the future.
With the help of AI and other technologies, it’s possible to streamline operations and tasks that are too tedious for humans, which can lead to mistakes. More importantly, these models are used to find inefficient areas that need improvement. That’s when tailor-made financial modeling plays a crucial part.
Costs and Limitations
Despite their undeniable usefulness, financial models aren’t “oracles” that can tell the future. These models are based on previous data, which may not play out the same way in the future as it did in the past. Moreover, the models must be fed accurate information and updated regularly, risking becoming useless otherwise. It’s also important to remember that building such models can be quite costly, especially the most complex ones.
How to Build an M&A Model
The first step to creating an M&A model is to gather all data that’s available regarding both parties. Performance metrics, liquidity measures, financing, income, and costs are some of the variables taken into account. Above all, this data must be completely free of incorrections to ensure its input will be, indeed, valuable.
All models are based on assumptions, and these assumptions must be made very carefully. It’s necessary to estimate the value of goods and services, fixed costs, and pre-tax and post-tax performances. The valuation model will emerge from the combination of all these inputs. There isn’t a one-size-fits-all solution, and different cases may require different models, including cash flow assumptions, for instance.
FAQ
What is financial modeling, and how does it apply to M&A?
Companies create financial models to analyze business prospects based on balance sheets, cash flow, and other financial information. Such models have been extensively used in the stock market. However, since they can predict a company’s performance in the short and long terms, they have also become vital in merger and acquisition operations.
How much does it cost to build and maintain a financial model?
The costs of these models can vary considerably, depending on their size and complexity. Anyway, it can be costly for companies to create one and, more importantly, keep it updated with high-quality information.
What is EPS?
EPS stands for Earnings Per Share, and it’s calculated by dividing the combined net income by the new total number of shares. When the new value is higher than before the merger, it’s a deal accretion; otherwise, it’s a dilutive deal.
