How do you use P&L variance analysis in M&A due diligence?

1 What is P&L variance analysis?

P&L variance analysis is the process of comparing the actual results of a company with a budget, forecast, or prior period. The difference between the actual and the expected results is called the variance, and it can be positive or negative. P&L variance analysis can be performed at different levels of detail, such as by product, segment, region, or function. The purpose of P&L variance analysis is to understand the drivers and implications of the variance, and to take corrective or strategic actions if needed.

3 How to conduct P&L variance analysis in M&A due diligence?

Conducting P&L variance analysis in M&A due diligence requires obtaining and analyzing the target's income statement and related documents. It is also important to understand the target's business model, industry, and competitive environment. Choosing a relevant comparison period and basis is the first step. You can then calculate the variances for each line item, using a simple formula or bridge analysis. After that, analyze the causes and effects of the variances to investigate reasons behind them, as well as their impact on the target's financial performance and profitability. Qualitative and quantitative methods can be used to gather more information and insights. Finally, report and communicate the findings and recommendations to summarize results of the P&L variance analysis, highlight key issues, provide recommendations on how to address variances, and how to improve the target's financial performance and profitability.

4 What to look for in the target's income statement?

The target's income statement provides a comprehensive overview of its revenue, cost, and profit, which reflects its business strategy, operations, and risks. When conducting P&L variance analysis in M&A due diligence, you should analyze the target's revenue by product, segment, region, or customer to identify the drivers and trends of its sales growth or decline. Additionally, you should check the quality and reliability of the target's revenue recognition and inventory valuation. Furthermore, you should calculate the target's gross margin as the difference between revenue and COGS, divided by revenue. You should also analyze the target's operating expenses by function to identify the drivers and trends of its operating efficiency or inefficiency. Moreover, you should calculate the target's operating income as the difference between gross margin and operating expenses. Finally, you should analyze the target's other income and expenses to identify their drivers and trends. Comparing the target's net income with its budget, forecast, or prior period, as well as with its peers or industry averages can help you identify the factors that affect its net income.

5 How to use P&L variance analysis in M&A valuation and negotiation?

P&L variance analysis can be a beneficial tool for estimating the target's value and negotiating the deal terms. For instance, you can use the target's historical and projected P&L to calculate its EBITDA, free cash flow, and EPS. You can adjust these figures for any non-recurring or exceptional items that may affect the target's earnings. Additionally, you can use the P&L variance analysis to identify and quantify any synergies or risks that may affect the deal value and benchmark and negotiate the deal terms accordingly. By comparing the target's P&L with its peers or industry averages, you can justify your offer or counteroffer based on the target's financial performance and profitability.