When thinking of buying a business, the price may not always be your first concern; but price alone should never be your only criterion for evaluation of an acquisition target. Of the many components of any acquisition target evaluation process, the most important is understanding their financial data as provided through a Confidential Information Memorandum (CIM).
So, what is a CIM? In short, a CIM acts like the resume for any business; it provides information about their financial performance – what works, what doesn’t work as well, and the expected performance in future years. Therefore, understanding CIMs is integral in making intelligent business acquisition decisions.
Financial Metrics as Your Map
Think of financial metrics as treasure maps. They serve as guides through a maze of potential acquisition targets to the prize: an investment worthy of consideration. Failing to utilize or misinterpreting financial indicators could leave you unwittingly investing in an unsuccessful opportunity.
As soon as you dive into a CIM, numbers may seem endlessly numerous and overwhelming – don’t get discouraged; numbers tell a tale and can give an accurate reflection of business health if read correctly. One key indicator should be metrics that provide clear evidence about its health status.
Key Financial Metrics You Need to Know
1. EBITDA: Visible Profitability
EBITDA, or Earnings Before Interest, Tax depreciation, and Amortization, measures how much profit the business generates through its core operations without factoring in external costs like taxes or interest on debts. Ultimately this number reveals its profitability to shareholders.
2. Revenue Trends: What Is the Growth Story?
A company’s revenue provides us with information about the amount it’s making each year. But trends can provide even more important clues: has its revenue been steadily growing or has it experienced decline over time?
When reviewing revenue in the CIM, look for patterns. If the company’s revenues are increasing steadily over time, that’s an encouraging sign; but if revenue appears erratic or declining it’s time to determine why.
3. Debt-to-Equity Ratio: Are They Over-Leveraged?
Businesses may appear profitable on paper, yet could still be overwhelmed with debt. The debt-to-equity ratio gives an accurate indication of this by comparing company debt with equity capital in an organization; giving insight into which forms provide financing of its activities (i.e. debt vs equity financing).
An elevated debt-to-equity ratio may signal that your company has overleveraged itself and could spell future trouble when cash flow dips, making debt payments increasingly challenging to handle. Therefore, when seeing such high ratios it’s wise to investigate why.
4. Cash Flow: Can the Business Pay Its Bills?
We all know the saying, “cash is king”, which rings especially true in assessing potential acquisitions. Positive cash flow means the company can cover its bills while also investing back into itself; any sign that an acquired business doesn’t generate sufficient amounts is a major red flag that requires further investigation.
As part of your CIM analysis, pay particular attention to both operating and free cash flows. Operating cash flow gives an idea of the cash generated from daily operations while free cash flow reveals how much is left after capital expenses have been made by your business.
5. Profit Margins: Do They Meet Expectations?
Margins play a vital role. A company with strong gross and net profit margins shows they can produce goods or services at a profit and retain some for themselves.
Interpreting CIM Data
After developing an understanding of which numbers you should seek in CIM analysis, the next step should be interpreting them critically and making sense of them within context. Don’t simply accept numbers at face value but seek deeper meaning from their use in various environments.
If a company’s revenue dropped during a recent quarter, for instance due to an event like product recall, or is part of an overall trend, then consulting a financial advisor or M&A expert is essential in order to identify these nuances accurately and provide advice as to how best to interpret them.
Conclusion
Financial metrics should only ever serve as part of the decision-making puzzle; they offer clues but cannot fully illuminate an investment opportunity. To make an effective choice, other considerations must also be considered – like where this target fits within your overall acquisition strategies or which industry trends might impede its performance in future years.
