Mergers, Acquisitions, Divestitures, and Other Restructurings, + Website

Chapter 9Balance Sheet Adjustments

Now that we have worked on much of the cash flow statement, it is a good time to construct two supporting schedules needed in order to complete the cash flow statement and to fill some holes in the income statement. These are the “Depreciation and amortization” and “Working capital” schedules. These schedules, however, are dependent on balance sheet information. Depreciation and amortization are dependent on net tangible and intangible property value, and working capital is dependent on current assets and current liabilities. So in a transactional situation, it is better to first construct a pro-forma balance sheet from which the depreciation and amortization and working capital schedules will be built.

To best explain how to construct a pro-forma balance sheet, let's first discuss what happens to a balance sheet when a buyer comes into the business.

The Buyer Is Paying For

• Shareholders' equity at a premium (purchase price): The price negotiated for a transaction can represent the book value of the business (which is identified by shareholders' equity on the balance sheet). However, it is common for a buyer to pay a higher value for the business than what is stated as its book value. First, companies can have a public market value that most likely trades at a premium to book value. Second, to properly incentivize the seller, a buyer typically pays a premium to the market value. This is called a control premium. That premium can be represented ...