How to check if the business plan is integrated
During your due diligence work in a M&A transaction, you will often have to perform a business plan review. Sometimes you will even set up a business plan by yourself. This task is fascinating as it combines the insights from the balance sheet and income statement analysis of the historical figures.
But how can you cross-check if the business plan is integrated? Integrated means that income statement, cash flow, and balance sheet are connected.
Let’s look at aspects from the P&L and balance sheet but before that — let’s ask the ultimate question.
The ultimate question
Does the cash flow reconcile to the change in cash and cash equivalents on the balance sheet? If that’s fine, then you can confirm that the model is technically integrated.
Now, let’s look at the income statement.
Top-line projections (sales, gross profit) also impact several expense items. For example, personnel expenses and other operating expenses. Here’s why:
- Personnel expenses reflect the number of employees. Thus, a significant change in the top-line goes in line with a change in the employer basis. Unless the company can adjust the capacity of its employees. This is something that you would need to discuss with the firm.
- Other operating expenses should also move in line. Other operating expenses consist of a fixed and variable part. Take office rent as an example. Up to a certain capacity, the rent will stay flat but changes if a certain threshold is exceeded. Hence, other operating expenses also need to be in line with the top-line.
Also here, the capacity topic will be present. A significant top-line development could potentially require a change in the asset base. For example, an industrial manufacturer increases the number of units produced. How could this work?
- The number of shifts is increased,
- some production is outsourced,
- the equipment hasn’t been used to full capacity by now, or
- an expansion is planned.
That’s also something that you’ll need to check to understand the development. Also, you should check if the capex projection and depreciation & amortization are consistently planned in the balance sheet and income statement.
To understand projected working capital, one quick way is to calculate DIO, DSO, and DPO. If you compare historical figures with the projected figures, you’ll also see the development — which you need to check. If factoring is applied in the future or changes to the supply chain are made, then expect that this is potentially reflected in these KPIs, as well.
This aspect mainly relates to tax liabilities, additions to provisions, or pensions. The changes in the balance sheet from period to period should be consistent with the corresponding expenses in the income statement.
- Top-line developments impact expense lines
- Capacity topics could relate to assets, employees as well as rented equipment or offices
- Working capital reflects any changes made to the supply chain
- Expense items for liabilities or provisions should reconcile to the balance sheet
Challenging a business plan or setting up a business plan is a great task to apply all the knowledge for the assignment and put it into work. Stories and numbers need to match. Ultimately, you should ensure that the business plan considers all pieces. The balance sheet, cash flow, and income statement need to be in line.
Hi, I am Jan, creator of the blog https://passion-for-finance.com/