Question

How does the ratio analysis help us in M&A analysis?

Answer 1

M&A involves an extensive analysis of a business's operations. When a company decides to acquire another, it will usually shortlist many different potential targets before finally deciding on one. During this process, the acquirer will critically analyse all of the potential targets using many different approaches, one of which is ratio analysis. Ratio analysis can be very useful in judging a company's financial position and in coming up with a fair value of that company. Some important ratios that are used in M&A are:

• Price/Earnings and EV/EBITDA: Both these ratios are very frequently used in M&A analysis and they help value a business which is one the most important parts of an M&A deal. These ratios give a sense of how much should be paid or is being paid for every dollar of the company's earnings.
• Debt/Equity: This is again a very important ratio. The acquirer is always very concerned with the capital structure of the potential target companies. This is because the acquirer is not just acquiring the equity but also the debt of its target and so this ratio also helps in valuing the target company.
• Liquidity ratios such as current ratio, quick ratio etc: These ratios give a sense of how liquid a company is and how well is it able to meet its working capital needs. This is important to consider for the acquirer because if the target is not able to meet its working capital requirements, the acquirer may have to inject extra money into the company which will change the value of the target.