An information memorandum is necessary to prepare for mergers and acquisitions. It provides a summary of your business to potential buyers, so naturally it is important to write it properly. Keep in mind that your business’s biggest selling point will be it’s past financial performance, but the buyers will want to know about the potential for future success as well. And here is where Financial Modeling comes into play.
What are financial models?
Financial modeling is a process of making an overview of a company's finances in the form of a spreadsheet. Using a mathematical equation a financial model is made in which any variable can be changed to create different scenarios and outcomes. They are usually used for making business decisions, managing a company, setting budgets and organising projects. But they are also a necessary component in mergers and acquisitions, which is why they are included in Information Memorandums.
Financial modeling process can be lengthy, but it can be broken down into a few steps.
- Collect your financial information
Financial modeling starts by collecting all of your financial history, your sales records, costs and expenses. The further back you go the better. But for the most optimal results, collecting at least 3 years of your financial history will be enough for making the most accurate financial models.
- Study your numbers
After gathering every financial piece of information you have, it is time to analyze it. Try spotting common trends and reocccurancess. Study growth rates and turnovers. Learn everything you can form your financial ratios. This will later be useful when trying to make financial projections for your business.
- Make assumptions
Making assumptions about your business’s future performance is done through drawing conclusions from what you previously learned from your analysis, or by doing market research. Understanding market trends can greatly help with determining the future performance of your business. Since you will make assumptions based upon what you already know, it is beneficial to collect as much information as possible, and Market Research can be of great help.
- Make financial projections
After making your assumptions, proceed to build upon them by creating financial projections based on a three statement model (income statement, balance sheet and cash flow). This may be the most important part of your information memorandum since it will show the buyers your business may have a promising financial future.
- Run assessments and analyses
The next step is to conduct additional tests and analysis, because Financial Modeling can not be complete without them:
- Discounted cash flow analysis (DCF model) - calculate the value of your company
- Sensitivity analysis - make different scenarios by changing the variables in the model to test different outcomes. This means adjusting the assumptions you made and seeing how the changes to the assumptions will impact the final result.
- Stress testing - test the model by assuming the worst case scenario. This way you will be able to see if your business will be able to withstand extreme circumstances.
Since financial modeling is such an integral part of an Information Memorandum it is important to do it right. Going carefully through each step will assure your model will be convincing and accurate.
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