Benchmark Service: A Key Facilitator
There are numerous risks involved when a company decides to purchase another through a merger and acquisition. One risk is an acquiring company failing to conduct a thorough analysis of the financial state and performance of the merging company. This could inevitably lead to financial losses and unforeseen complications soon after the purchase has been completed. Since mergers and acquisitions deals can cost hundreds of billions, it is natural that acquiring companies need adequate financial and background information for a potential acquisition. Enter benchmarking services, the process through which an acquiring company can gather the vital information it needs to execute a successful merger and acquisition.
Setting The Standard
Benchmarking services analyse the market performance and financial strength of the company in question and compare it to the industry standard. Such a comparison allows all parties involved to hold objective, informed discussions based on accurate data, which helps facilitate efficient and transparent deals. There are three approaches to benchmarking a company to the industry standard. These are the market approach, the income approach, and the asset-based approach. Any or all of these approaches are utilized by experts to create a comprehensive report on the market performance and financial strength of a company. In the case of mergers and acquisitions, the most used is the market approach. This is because it directly compares the value of the company in question to market transactions of similar companies.
Metrics Essential for Financial Analysis
In a financial analysis via the market approach, there are three categories in which a company is compared to its industry leaders and competitors. These are:
Common size analysis
A trend analysis is a review of the company’s financial statements for the most applicable period. It serves two primary purposes. The first is to search for anomalies in the historical growth patterns of a company, and the second is to predict future results. A stable growth pattern increases the valuation of the company, whereas an unstable one decreases valuation and assists in the prediction of future growth trends. A company’s future growth is measurable by comparing the fixed and variable costs of a company to other players in the industry. This allows for an assessment of whether the initial valuation was accurate and whether any adjustments are needed.
Common Size Analysis
A common size analysis allows experts to determine whether a company has been overleveraged by industry standards. Being overleveraged means having excessive debt, and a company with excessive debt will suffer a lower valuation. A common size analysis is obtainable by tracking the financial statement line items (assets, liabilities, and profit) from year to year.
Additionally, common size analysis allows for in-depth cost analysis that allows a particular company to discover whether certain costs are at odds with the industry standard. This can include employee salaries, advertising expenses, and other departments within the company.
A financial ratio compares current assets to current liabilities (which provides the current ratios). There are four primary areas in which the ratio of a company is measurable against the industry standard. These are liquidity, leverage, profitability, and operations. Analysts look at fluctuations in the current ratios for these four sectors and compare these ratios to industry benchmarks.
The performance of a company’s ratio is measurable by an index, in which each sector is measured and linked to the industry standard. A value above one indicates that the company is above the industry benchmark, whereas a value of less than one denotes that it is below it.
Benchmarking Services in M&A
It is fair to say that benchmarking a company’s performance against the industry is an extremely important tool in assessing mergers and acquisitions. By comparing a potential merging company’s performance to the industry standard, parties are in a better position to evaluate the financial stability and financial performance of the merging company.
There are three approaches to benchmarking a company during a merger and acquisition, of which the most popular approach is the market approach. A market approach is divided into three categories: trend analysis, common size analysis, and ratio analysis. The data provided through benchmarking becomes the focal point of discussion for all parties involved, ensuring benchmarking servicing’s place as an essential step in the merger and acquisition process.