Legal Blog

M & A Nuggets: Drill Down on Earnings

shutterstock_388459930To determine a purchase price to offer to the seller, purchasers most often analyze some form of the target’s earnings, whether EBITDA, net cash flow or some other measure.  When analyzing the seller’s income statement and statement of cash flows, care must be taken to make sure that the earnings number you use supports your purchase price. For example, EBITDA is often used as a key measure to determine purchase price.  EBITDA means earnings before interest, taxes, depreciation and amortization.  Often, however, only depreciation, and not amortization, is added back to determine EBITDA.  With the emergence of technological, internet based and biotech companies in the past decades, the presence of amortization on a target’s income statement has become much more prevalent, and therefore must be taken into account. Next, as a result of a recent change in accounting principles, one line item on the income statement, known as extraordinary items, will no longer stand out.  In the past, companies were required to report extraordinary items as separate line items on the income statement.  Beginning with fiscal years starting December 16, 2015, extraordinary items will no longer be reported as separate line items.  Care must therefore be taken in the due diligence process to inquire about and investigate extraordinary items.  Last, it is important that you understand whether there have been any changes in accounting principles used during the years of the earning statements you are examining.  If there have been changes in accounting principles, your understanding of them will allow you to smooth out the earnings.  There are many other earnings statement items that must be carefully analyzed, but the bottom line is that a forensic analysis of your target’s earnings statement must be conducted to assure that you are not overpaying for your target.


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Glenn D. Solomon Esq., is a principal at the law firm of Offit Kurman and has provided counsel to businesses and business owners for more than twenty-five years, with extensive experience in the purchase and sale of businessesstructuring ownership agreements, and advising companies in financial distress






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