develop a financial model

How to Develop Financial Modeling for a Business Acquisition

In our previous articles in this series, we’ve discussed the first two steps of the business expansion through acquisition process—defining your acquisition strategy and identifying target companies. After your firm has worked for hours developing an acquisition strategy and identifying a target firm meeting your acquisition goals, it’s time to move on to the third step: building a business case and developing financial modeling. If you need a refresher on all seven steps of the expansion through acquisition process, you can review them below:

  1. Define your acquisition strategy 
  2. Identify target companies
  3. Build a business case and develop financial modeling 
  4. Due Diligence
  5. Deal Structure negotiation
  6. Sign and close
  7. Post-close integration

How To Develop a Financial Model

Once a target firm has been identified, building a financial model is the next step to solidify your decision to move forward with an acquisition. Financial modeling is a broad term that can be used to describe a multitude of various financial models for analysis. 

A financial model could be used to determine the acquisition company’s value, how shares of ownership will be transferred, and how a target company’s financials will affect your firm’s financials and overall stock value. A financial model can also provide insight for various “what if” scenarios and cover many prerequisites necessary for proceeding down the path to acquiring a new company. 

What Is a Financial Model?

While the term “financial modeling” sounds complex, and it certainly can be, the most successful models tend to keep it simple. A model is typically staged in an excel spreadsheet format, and should be presented in a manner that is well documented with the assumptions used and easily understood by the key decision-makers. 

The old adage “garbage in, garbage out” never holds more true than with financial modeling. Creating the most dynamic and well-laid-out model is ineffective if the inputted data has not been verified or is unrealistic in terms of projections. When “garbage data” is input into a model, the output is also “garbage.” These inaccurate results will create a situation where the key decision-makers are making big decisions based on inaccurate assumptions and unrealistic projected outcomes. 

The Four Main Types of Financial Models & Questions to Ask

When moving forward with a potential business acquisition, key financial models that help influence the decision to move forward or not are imperative to good decision making. Below is a selection of commonly used financial model scenarios that assist leadership with decision making: 

  • Valuation Model: How much is the target company worth based on its historical performance and projected performance?
  • Model of Projections: What is the projected performance of the target company?  What is the projected performance of your firm?  Are they realistic based on the historical performance of the target firm?  Are they realistic based on the strategic plan of the target firm?
  • Consolidated Financial Model: Based on the target firm’s historical and projected financials, what would a consolidated profit and loss statement look like when combined with your firm’s historical and projected financials?  What would a consolidated balance sheet look like? Is the acquisition diluting your earnings and stock price? What does a consolidated cash flow look like? Can we maintain a positive cash flow with this endeavor?
  • “What if” Scenario Modeling: Once the acquisition is complete, what if you increased revenue by 10% over projections based on the synergies of the two firms?  What if you need to hire five, six, or ten more professionals?  What if you need to invest in a significant IT overhaul to get the acquisition up to the same level of technology as your firm?

Contact Thinc Strategy for Merger and Acquisition Advisory Services

As you can tell, financial modeling can be both a powerful tool to assist decision-makers with critical acquisition decisions and overwhelming when trying to identify the key models needed. Instead of going through the acquisition process alone, turn to Thinc Strategy. Once you contact us, we’ll welcome the opportunity to provide you with the tools necessary to create a strategic financial model and make the most well informed decisions for your organization! 

To receive a merger and acquisition advisory service consultation, please contact us today. If you want more information on all seven steps of the merger and acquisition process, be on the lookout for our next topic — due diligence.