One of the most important exercises our award-winning evaluation team conducts during the initial evaluation phase of our client engagements is a full profit margin/ratio analysis examining both in to two key areas:
From an M&A analysis and modeling standpoint, both are critical. Why do we do this during our initial evaluation of each client? Because buyers will be doing the same. We want to be able to clearly highlight positives regarding our client’s margins and/or create meaningful strategies for them to improve or enhance their margins/ratios in both areas.
Since many of you did not major in corporate finance while in college and few of you are CPAs, we will first delve into the financial analysis area, industry norms, and in our next article we will explore the importance of margins by line.
First, comparing your margins to industry norms is a creative way of determining where your business stands in relation to your competitors. Although many sources exist for this information, the market-accepted organization that has compiled the most relevant industry norm data is the Risk Management Association (RMA). I have been using their data for more than 30 years and have found that is has improved greatly over time as they gather more and more relevant industry financial information.
According to their website, the RMA:
Is a not-for-profit, member-driven professional association serving the financial services industry. Its sole purpose is to advance the use of sound risk management principles in the financial services industry. RMA promotes an enterprise approach to risk management that focuses on credit risk, market risk, operational risk, securities lending, and regulatory issues. Founded in 1914, RMA was originally called the Robert Morris Associates. Today, RMA has approximately 2,500 institutional members. These include banks of all sizes as well as nonbank financial institutions.
Given its longevity, size, and the scope of work, I have found RMA to be a very credible source of industry margin comparisons. Although they produce a number of reports in a variety of useful formats, what is most applicable for business valuation purposes is their RMA Annual Statement Studies, which provide annual information regarding industry margins for banking, valuation and consulting professionals. Again, per their website:
RMA's Annual Statement Studies® is the only source of comparative industry data that comes directly from the financial statements of small and medium-size business clients of RMA’s member institutions. For over 97 years, RMA has been the leader in providing the industry with reliable, and accurate benchmarking figures including balance sheet and income statement line items, and 18-classic industry average ratios.
If you would like to see a sample of their ratio analysis in action, you can do so here (this is for the soybean farming industry so any of you in that niche now have comparable data you can use).
If you drill into the link above, you will see compiled balance sheet and income statement data from industry players and a series of key ratios that can be used to compare a specific soybean operator to industry standards over several historical years, as well as by size of industry participant.
Two key areas that many buyers will look at are the Quick and Current Ratios of a target. For laymen, these are defined as:
It is easily seen why these two ratios are quickly reviewed by buyers who want to ensure the financial viability of their target investments.
As you can see in the example given of the soybean industry, the median Quick Ratio in the last historical fiscal year (second page for 3.31.15) is .7 with an upper quartile of 1.6 and a lower quartile of .2. So, from a financial analysis standpoint, you would want your operation to be closer to 1.6 than .2.
Likewise, the median Current Ratio is 1.2 with the upper quartile at 2.5 vs a lower quartile of .4. Here again, from a buyer’s perspective, it is hopeful that your target will be closer to 2.5 than the bottom end of the spectrum.
The good news for our clients is that if we see that either of these ratios (and several dozen others) are below industry norms, we offer a Roadmap to Enhancing Value document that outlines key metrics from a financial analysis standpoint that could lead to significant improvement. If you have a plan to improve any of your key ratios and margins, buyers will usually look far more favorably on your business than if you do not. And if a buyer asks you during due diligence to provide your Quick and Current ratios and you are unable to do so, red flags will go up immediately.
One of the unique features of the Generational Equity procedures and policies is the in-depth financial analysis that we do on our clients BEFORE taking them to market. This allows us to not only provide the owner with an opinion of value, but also enables us to analyze key financial metrics in relation to industry standards and provide our client with ideas on improvement – this will be key when eventually talking with buyers.
To learn more about M&A financial analysis, I recommend that you attend a Generational Equity M&A executive conference. These no-obligation meetings are designed to allow you in a few short hours to gain significant knowledge about how important your preparation for an M&A event can be.
To learn more, call us at 972-232-1121 or email us at firstname.lastname@example.org.
By Carl Doerksen, Director of Corporate Development at Generational Equity.
© 2017 Generational Equity, LLC. All Rights Reserved.
Greetings Mike. Thank you for the captivating and compelling presentation you made at the Phoenix presentation last week. Over many years in business yours was the most informative and well-presented presentation, on any subject, that I have ever attended! Your energy and enthusiasm combined with your concise and captivating support of your positions with easily understood examples and data was compelling.Pete L.
Thank you again for all your guidance and support. Any company will achieve what they intend, if they have you on their team!Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
Michael worked tirelessly, He followed every lead meticulously and urgently to make sure nothing was missed.Robert Evans, President and CEO of Mealtracker Dietary Software
We are extremely pleased with the way Generational Equity handled the sale of our company. Your associates, Tom and Chris, did an outstanding job of getting us (me) through the process.Michael J Polarek, President, Paragon Packaging
We thank you Eric and Generational Equity making our dream come true.Larry Moore, Owner, A Company Portable Restrooms
We will highly recommend Generational Equity and Musa Jagne to any business owner about to embark on the same process.Karen S. Williams, CFO, BW Manufacturing
Thanks again Phil and feel free to have a future client call me if they would like a referral. You are a true professional!Andy Graham, Vice President, Modern Heating & Plumbing
Bruce and I wanted to take this opportunity to thank Generational Equity for assigning Musa Jagne to our transaction. In Bruce’s words, “Musa did one hell of a job for us!”Karen S. Williams, CFO, BW Manufacturing
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We were happy to see the interest in our company and what we cherished has not just a valuable company but an important company to the communities we served in.Larry Moore, Owner, A Company Portable Restrooms
The help you provided us during each step of this process made us feel very comfortable and confident we were selecting the right approach to transition our Company.Andy Graham, Vice President, Modern Heating & Plumbing
We knew it would be a difficult task to have someone really understand our business and our market, prior to researching a possible buyer, so it was imperative that we found someone of your caliber, with definite proven experience in this area.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
I would like to thank you and your firm, Generational Equity, for being our valued advisors in our journey.Bil MacLeslie, CEO, ipHouse
Your wisdom and experience were invaluable to me during this once-in-a-lifetime transaction.Ralph Noblin, President of Noblin & Associates
We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
I wanted to write you a quick letter to express our appreciation and our delight on the outcome of helping us through the process of our recent sale. We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Terry D. Wickman, President, Keytroller
Generational Equity educated and informed us – so that we could be on the upside of a good decision (to sell).Bil MacLeslie, CEO, ipHouse
I quickly recognized that Don was working for Sharpe Mixers above all else, and held our interests above others.Jay Dinnison, Owner of Sharpe Mixers
I must say that I have never worked with a more driven, competent and focused individual as Don Ho.Jay Dinnison, Owner of Sharpe Mixers
I couldn’t have asked for a better team than Michael and Deborah. We couldn’t have done it without them.Robert Evans, President and CEO of Mealtracker Dietary Software
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