Blog · Finance metrics and formulas · Finance and FP&A teams
Compare an acquisition target's historical revenue, margins, working capital and cash conversion. A worked US business example shows what the trends establish, which questions they raise and who should resolve them.
Financial statement analysis in mergers and acquisitions compares a target's historical growth, profitability, working capital and cash generation before the team explains what changed. The strongest result is a set of reconciled findings tied to records the seller can provide. Historical ratios support those questions; they do not establish the business's value or certify a transaction review.
Begin with the reporting perimeter: which legal entities, locations and activities are included in each year? A target that added a division between periods is not the same operating base, even when both statements use the same company name.
Collect the income statements, balance sheets, cash flow statements and notes for matching fiscal years. Add monthly ledger exports, receivables aging, inventory schedules and supplier payables when the initial comparison identifies a question. The monthly financial report template gives finance a consistent layout for the statement sources.
The SEC's financial statement guide explains that a balance sheet is a snapshot while income and cash flow statements cover periods. It also distinguishes earnings from actual cash movements. An acquisition review needs all three views to understand whether reported growth brought cash into the business.
Consider an illustrative US industrial distributor with fiscal years ending December 31. These are teaching inputs, all in USD, with unchanged accounting policies and no acquisition or disposal between the years. Opening operating working capital comes from the preceding year-end schedule.
| Source line | 2024 (USD) | 2025 (USD) |
|---|---|---|
| Revenue | 12,000,000 | 14,400,000 |
| Cost of goods sold | 7,800,000 | 9,504,000 |
| Operating expenses | 3,000,000 | 3,600,000 |
| Net income | 800,000 | 850,000 |
| Noncash operating adjustments | 400,000 | 550,000 |
| Opening operating working capital | 1,600,000 | 1,800,000 |
| Closing trade receivables | 1,500,000 | 2,100,000 |
| Closing inventory | 1,200,000 | 1,600,000 |
| Closing trade payables | 900,000 | 1,100,000 |
| Reported operating cash flow | 1,000,000 | 600,000 |
Operating expenses include all operating costs below gross profit. Net income also reflects the interest, tax and any other below-operating items in the supplied accounts; do not assume the difference between operating profit and net income is all interest.
Use these definitions consistently:
Gross profit = Revenue - Cost of goods sold
Operating profit = Gross profit - Operating expenses
Operating working capital = Trade receivables + Inventory - Trade payables
Operating cash conversion = Operating cash flow / Net income
The operating working capital definition here excludes cash, debt, taxes and other operating balances. It is an analytical definition for this example, not an agreed transaction working-capital measure.
Calculate from the unrounded source amounts. The results below show percentages to two decimals and conversion ratios to two decimals.
| Measure | 2024 | 2025 | Calculation |
|---|---|---|---|
| Gross profit (USD) | 4,200,000 | 4,896,000 | Revenue - COGS |
| Gross margin | 35.00% | 34.00% | Gross profit / Revenue |
| Operating profit (USD) | 1,200,000 | 1,296,000 | Gross profit - Operating expenses |
| Operating margin | 10.00% | 9.00% | Operating profit / Revenue |
| Closing operating working capital (USD) | 1,800,000 | 2,600,000 | Receivables + Inventory - Payables |
| Operating cash conversion | 1.25 | 0.71 | Operating cash flow / Net income |
Revenue growth is ($14,400,000 - $12,000,000) / $12,000,000 = 20.00%. Operating profit growth is ($1,296,000 - $1,200,000) / $1,200,000 = 8.00%. The target sold more while retaining a smaller operating share of each revenue dollar.
That is a question for the commercial and finance teams, not an explanation by itself. Request revenue and cost detail to separate selling prices, volume, product mix and purchase costs. Check whether the same freight and labor costs remain in COGS in both periods before attributing the margin movement to operations.
CFA Institute's financial analysis techniques describes ratios as indicators of what happened that still require explanation of why. Its framework also puts the purpose of the analysis before data collection. Here the purpose is understanding historical operating performance, rather than choosing a valuation assumption.
Closing operating working capital increased by $800,000: $2,600,000 - $1,800,000. The components prove the movement:
| Component | Change in balance (USD) | Effect on cash (USD) |
|---|---|---|
| Trade receivables | 2,100,000 - 1,500,000 = 600,000 | -600,000 |
| Inventory | 1,600,000 - 1,200,000 = 400,000 | -400,000 |
| Trade payables | 1,100,000 - 900,000 = 200,000 | 200,000 |
| Total | Operating working capital increases 800,000 | -800,000 |
For this simplified example, assume those are the only changing operating balances and there are no other operating cash adjustments. The cash bridge is then:
| Operating cash reconciliation | 2024 (USD) | 2025 (USD) |
|---|---|---|
| Net income | 800,000 | 850,000 |
| Add noncash operating adjustments | 400,000 | 550,000 |
| Less increase in operating working capital | -200,000 | -800,000 |
| Calculated operating cash flow | 1,000,000 | 600,000 |
The 2024 working-capital use is $1,800,000 - $1,600,000 = $200,000. In 2025, $850,000 + $550,000 - $800,000 = $600,000, matching reported operating cash flow. For real accounts, include every relevant operating asset, liability and other adjustment until the residual is zero.
The controller owns reconciliation to reported statements. Commercial leaders explain sales and mix; operations explains inventory; the collections owner explains receivables aging. Record the requested schedule, responsible person and unresolved question beside each finding.
Keep seller adjustments in a separate bridge with evidence and approval status. Do not overwrite reported operating expenses with an asserted recurring figure. Likewise, expected transaction benefits belong in a different view: the SEC's Financial Reporting Manual discussion of pro forma information treats acquired-business statements and accompanying pro forma information as distinct presentations.
Mergers and acquisitions financial modeling addresses the separate forward-looking exercise. When the historical accounts show weakening cash or coverage, financial distress analysis gives the operating warning-sign review. For file checks and interpretation boundaries, see AI for financial analysis.
Upload the target's comparative statements and supporting workbook; Covirage maps the columns, and its tools compute and check the margins, working-capital movements and cash comparisons. The external AI model explains the historical findings with every figure traced to its rows. Create a free Covirage account and bring a sample of your own target reports.
See Covirage for finance teams.
Start with comparative income statements, balance sheets and cash flow statements, together with their notes and accounting policies. Request the underlying ledger and working-capital schedules for material movements. Confirm the statements cover the same entities before comparing periods.
Growth can require more inventory and leave more sales unpaid in receivables. If those increases exceed the financing provided by supplier payables, operating working capital absorbs cash. Examine the movement alongside earnings and the full operating cash reconciliation.
No. Historical accounts describe the target's reported business over past periods. Pro forma presentations incorporate specified transaction effects and assumptions. Keep those views separate so that an expected post-transaction improvement does not appear as an achieved historical result.