Adjusting Your Financial Statements for M&A Excellence

M&A’s are pivotal for any company, potentially steering its trajectory toward unprecedented growth and success. At the heart of achieving M&A excellence is the often-overlooked art of adjusting your financial statements. This enhances your company's attractiveness and ensures transparency and compliance throughout the M&A process.

Why Financial Statements are Adjusted for M&A

Adjusting financial statements for M&A is necessary to ensure transparency and foster informed decision-making. This adjustment process serves multiple critical purposes:

  1. Harmonizing Accounting Practices: Diverse accounting standards among companies can make true financial performance clear. Adjustments create a level playing field, allowing for accurate comparisons and valuations by aligning accounting methodologies across entities.
  2. Revealing Economic Reality: Normalizing earnings and removing one-time items offers a clearer view of sustainable profitability. This is crucial for understanding a company's ongoing operations and genuine value in an M&A context.
  3. Asset and Liability Reassessment: Adjusting assets and liabilities to their fair market values reflects a more accurate financial position, essential for making informed M&A decisions.
  4. Synergies and Future Projections: Accurately projecting synergies and incorporating them into financial statements is challenging but vital. It illustrates the M&A's strategic value and potential financial benefits of the M&A, providing a forward-looking perspective crucial for stakeholders.
  5. Regulatory Compliance and Investor Confidence: Transparent, adjusted financial statements demonstrate a commitment to integrity, fostering trust among investors and ensuring compliance with regulatory standards.

 Common Adjustments to Make in Financial Statements

Adjusting financial statements is a critical step towards M&A excellence, involving several key adjustments:

  1. Normalizing Earnings: This process strips out one-time or unusual revenues and expenses to showcase the company's operational profitability. It provides a clearer picture of ongoing earnings, which is vital for accurate valuation.
  2. Fair Value Adjustments: Fair value adjustments are assets and liabilities reassessed to reflect their current market value rather than historical cost. This ensures the financial statements accurately portray the company's worth during the M&A.
  3. Debt and Equity Adjustments: These adjustments recalibrate the value of a company's debt and equity to their current market conditions. It's essential for assessing financial structure, health, and the cost of capital.
  4. Eliminating Intercompany Transactions: Adjustments are made to remove sales, debts, or asset transfers between the merging entities, ensuring financial statements reflect only external activities and a clear economic performance.
  5. Adjusting for Operational Synergies: Estimations are made for cost savings and revenue increases expected from the merger, indicating the potential value creation and guiding decision-making.
  6. Provision for Future Liabilities and Contingencies: Provisions are set aside for expected future liabilities, providing a more accurate view of the company's financial obligations and risk profile post-merger.

 Adjustments That are Not Allowed

Certain adjustments to financial statements are strictly prohibited in the context of M&A, as they can mislead stakeholders or violate regulatory standards. Here are the main points to keep in mind:

  1. Artificially Inflating Earnings: Adjustments that unjustifiably increase earnings, such as recognizing future revenues prematurely or deferring expenses without a valid basis, are not allowed. These practices can give a misleading impression of financial health and performance.
  2. Manipulating Cash Flow: Adjustments that artificially enhance the appearance of cash flow, for example, by delaying payables or accelerating receivables without reasonable justification, are prohibited. Accurate cash flow reflection is crucial for assessing the company's liquidity and operational efficiency.
  3. Obscuring Liabilities: Failing to adequately disclose or adjust for known liabilities, such as off-balance sheet obligations or underestimating contingent liabilities, is not permissible. Full transparency regarding liabilities is essential for a true assessment of financial risk.
  4. Misrepresenting Asset Values: Overvaluing assets, either by overstating their market value or not adequately adjusting for impairment, is not allowed. Accurate asset valuation is key to determining the company's true net worth.
  5. Creating Unrealistic Reserves: Establishing reserves for future expenses or losses that do not have a reasonable basis is prohibited. Reserves must be based on realistic assumptions and estimations.

 Adjustments That May Be Allowed

Some adjustments can provide a clearer view of the financial outcomes post-M&A when applied judiciously. Here are the essentials:

  1. Pro Forma Adjustments: Pro forma adjustments simulate the financials as if the companies had been merged longer, offering insights into potential efficiencies and synergies. They must be based on realistic, well-analyzed assumptions.
  2. Synergies: Estimating merger cost savings and revenue enhancements are allowed when grounded in detailed, conservative analysis. These projections must remain realistic to avoid overestimation.
  3. Adjusting for Non-Recurring Events: One-off costs related to the merger, like integration or restructuring charges, can be adjusted. This helps portray a clearer ongoing operational cost post-merger but should not mask operational issues.
  4. Operational Realignment Costs: Costs for activities like rebranding or systems integration, which are necessary for achieving operational efficiencies, may be adjusted. This reflects the investment needed for synergy realization.
  5. Tax Effect Adjustments: Reassessment of tax-related items due to the merger, including deferred tax assets and changes in tax rates, is permissible. These adjustments offer a more accurate picture of future tax liabilities and benefits.

While these guidelines provide a framework for adjustments that may be permissible in preparing financial statements for M&A, the landscape can be complex and nuanced. Suppose you are still determining whether a specific adjustment is allowable or how to apply it properly. In that case, it is crucial to seek guidance. Contact your M&A lawyer for clarification and ensure your adjustments align with legal standards and best practices. Professional advice can help navigate the complicated landscape of M&A financial adjustments, ensuring compliance and safeguarding the integrity of the process.

 Final Tips for Making Adjustments

Successfully adjusting your financial statements for M&A requires attention to detail and strategic thinking. Here are key tips to ensure effective and compliant adjustments:

  1. Engage with Professionals: Seek out the expertise of accountants and financial advisors specializing in mergers and acquisitions. These professionals can provide key insights into the complex aspects of financial adjustments, helping to ensure accuracy in accounting standards and regulations.
  2. Maintain Transparency: Be transparent about the adjustments, including their rationale. Documenting and explaining each adjustment in the financial statements or accompanying notes builds trust with potential partners and regulatory bodies. Transparency helps stakeholders understand the financials' underlying assumptions, enhancing credibility.
  3. Be Conservative: When in doubt, opt for more conservative estimates and assumptions in your adjustments. Overly optimistic projections or aggressive adjustments can lead to unrealistic valuations and undermine negotiation trust. Conservative adjustments reflect prudence and reduce the risk of post-merger surprises.
  4. Ensure Documentation and Justification: Ensure thorough documentation and a solid justification for every adjustment made. This supports transparency and facilitates the review process by auditors, regulators, and other stakeholders. Proper documentation demonstrates due diligence and helps to validate the adjustments' accuracy and necessity.
  5. Regular Review and Update: The M&A process can be dynamic, with new information emerging that may impact financial adjustments. Regularly review and update adjustments to reflect the most current and accurate financial picture. This agility can be crucial in responding to negotiations and ensuring that financial statements accurately reflect the company's status throughout the M&A process.

Remember, achieving M&A excellence starts and ends with the thoughtful adjustment of your financial statements. This process, while complex, is integral to uncovering the true value of your business and clearing the way for a successful M&A.

Do you need help adjusting your financials for an M&A? Contact a Catalyst Legal representative for more information.


Get In Touch

We will be in touch shortly to see how we can assist your business with their legal needs.