Three Statements

WSO Investment Banking

Income Statement (I/S)

R v e enue
Technical Concepts CheatSheet -COGS (Cost of Goods Sold)
G ross Profit

-Operating Expenses
How are the three main Financial Statements Connected? O perating Income (EBIT)

-Interest Expense
Income Statement Balance Sheet Cash Flow Statement
+ Interest Income

Revenue Assets Beginning Cash P retax Income

Cost of Goods Sold Current Assets (Incl. Cash) Operating cash flow -Taxes
Long-Term Assets Net Income
Net Income
Gross Profit +/ - Non-cash Items
+ Share Count
Operating Expenses Liabilities Depreciation
PS
Depreciation Current Liabilities Amortization
E

Amortization Long-term Change in work. Cap.

Balance Sheet (B/S)
Debt/Liabilities
Operating Income Investing cash flow Current Assets
Interest Expense Sh areholders Equity Capital Expenditures
Cash & Cash Equivalents
Common Stock Other Investments
Pre-Tax Income Retained Earnings
Short-term investments
Taxes Financing Cash Flow Inventory
Net Income Dividends Accounts Receivables
Cash Raised/Spent on Dept. Long Term Assets PP&E
Cash Raised/Spent on Equity
Ending Cash Total Assets

Current Liabilities Short

Valuation Methodologies quity Value And Enterprise Value

E
Term Debt Accounts Payable

Long Term Liabilities

Comparable Company Analysis (also called Equity Value (also called "Market Cap") = Share Price x Long Term Debt
Number of Shares
"Public Comps" or "Trading Comps")
Total Liabilities
Enterprise Value (EV) = Equity Value - Cash & Cash
Analyze public companies similar in industry,

Equivalents + Debt + Preferred + Minority Interest Common Stock & APIC

business model, size, financials, and sometimes

geography. R etained Earnings

Diluted Share Count = Basic Share Count + Additional
Shares Issued From "Dilutive Securities" Total Shareholders Equity
Determine relevant valuation multiples from the
comparable companies.
Dilutive Securities include stock options, warrants,
restricted stock units, convertible debt, convertible
Cash Flow Statement (CFS)
Justify the appropriate multiple for the company
preferred stock, etc.
being valued, comparing it to the range from the

comp set. Typically, companies with higher growth

se "Treasury Stock Method" to calculate diluted shares
U O perating Activities
or margins command higher multiples, and vice
when it comes to Stock Options and Warrants. This means

versa.
N et Income
only "in-the-money" securities are converted to shares, and
the exercise proceeds are used to buy back as many shares + N on-cash Exp. (D&A, SBC)

Precedent Transactions (also known as "M&A as possible. +/ - Dec./Inc. in Working

Comps" or "Transaction Comps")
Capital
Common Valuation Multiples:

Look at recently acquired companies with

similarindustry, business model, size, financials,
EV/Revenue, EV/EBITDA, EV/EBIT, and P/E (same as Investing Activities
and sometimes geography. Market Cap / Net Income). -Capital Expenditures

There are additional, less common multiples tailored to

Determine the valuation multiples at which they
specific industries. Financing Activities
were acquired, including any control premiums paid.

+ Cash from equity/debt financing

-Share buyback/dividends
Justify the multiple for the company being valued Note: Enterprise Value should be used when comparing
relative to the comp set. Higher growth or margin metrics above the interest expense line on the income -Debt repayment
companies usually have higher multiples. statement, while Equity Value applies to metrics below the = Net Change in Cash
interest expense line fora consistent comparison.
 Discounted Cash Flow (DCF) Analysis e e s and Ac uisu ons (Acc e on Dilu on)
M rg r q ti r ti / ti

The concept is that a company’s value equals the sum The simplest way to evaluate a deal is by checking if the earnings per share (EPS) increases or decreases a er the ft

of its future cash flows, discounted to present value. transaction.

Calculate Unlevered Free Cash Flow for 5–10 years:
EBIT*(1-Tax) + Non-Cash Expenses +/- Changes in A deal is accretive if the post-transaction EPS is higher than the pre-transaction EPS.
Operating Working Capital - Capital Expenditures.
A deal is dilutive if the pre-transaction EPS is higher than the post-transaction EPS (which is undesirable).
Determine the Discount Rate, or Weighted Average
Cost of Capital (WACC): Cost of Equity * % Equity +
Cost of Debt * % Debt (1-Tax Rate) + Cost of To determine if a deal is accretive or dilutive, you essentially combine the income statements of both companies line by line.
Preferred Stock * % Preferred. For example:

Use the Capital Asset Pricing Model (CAPM) to BuyerCo’s revenue + SellerCo’s revenue = NewCo’s revenue
calculate the Cost of Equity: Risk-Free Rate + Levered BuyerCo’s CO S + SellerCo’s CO S = NewCo’s CO S
G G G

Beta * Equity Risk Premium.

Risk-Free Rate = US Treasury Yield
Unlevered Beta = Levered Beta / (1 + (1-Tax S o e ey ad ust ents to conside
m k j m r:

Rate) * (Debt/Equity))
Levered Beta = Unlevered Beta * (1 + (1-Tax - Revenue and cost synergies:
Rate) * (Debt/Equity) Revenue synergies could come from price increases or crosssell/upsell opportunities.
Equity Risk Premium = Stock Market Returns - Cost synergies might involve reducing headcount by eliminating redundant positions a er the companies merge.ft

Risk-Free Rate.
Deal costs depend on:
Calculate Terminal Value:
The purchase price, i.e., how much BuyerCo pays.
Exit Multiple Method: Multiply the nal year’s
fi
The payment method: whether BuyerCo is using cash, debt, stock, or a combination. Each method has a di erent cost ff

EBITDA by a relevant EV/EBITDA multiple from structure, ranked from lowest to highest:
comps.
Cash: cost comes from lost interest income.
Gordon rowth Method: Final Year FCF * (1 +
G

Terminal rowth Rate) / (Discount Rate -

G
Debt: involves incurring interest expenses.
Terminal rowth Rate).
G Equity:leads to an increase in share count, which reduces EPS because existing shareholders must share future
earnings with new shareholders.
Discount the pro ected Free Cash Flows and Terminal
j

Value by the discount rate to determine the At its core, the accretion/dilution calculation is straigh orward: tf

enterprise value. If SellerCo’s net income plus revenue and cost synergies are greater than the cost of the deal, the transaction is
Note: If using Levered Free Cash Flow, discount by the accretive.
cost of equity instead of WACC to derive equity value If SellerCo’s net income plus revenue and cost synergies are less than the cost of the deal, the transaction is dilutive.
instead of enterprise value.

Ste s in the
p LBO M odel : e e a ed uyouts (
L v r g B LBO )
Determine the purchase price. An LBO occurs when a private equity rm acquires a company using a combination of debt and cash, aiming to sell it for
fi

a pro t in -5 years. There are three ways to boost the internal rate of return (IRR):
Decide on the type and amount of debt, including
fi 3

interest rates and terms.

Purchase price: Buying the company at a lower entry multiple or selling it at a higher exit multiple.
Establish the sources and uses of funds.

Pro ect the nancial statements and calculate free

j fi
Financing structure : Maximi ing the debt load without risking bankruptcy. More debt increases the IRR.
z

cash flow (FCF).

Use FCF to pay down as much debt as possible. Company performance: G enerating more free cash flow helps pay down debt, increasing the equity available to the PE
Determine the exit price and calculate the internal rm when they exit.
fi

rate of return (IRR) using the formula: MOIC (1/ ^

years)-1.
Note: Although LBOs are not always mentioned as a Q uali es o st on
ti f r g LBO candidates
valuation method in interviews, if asked for a fourth
approach, you can discuss LBOs. The goal is to estimate
the highest price a private equity rm would pay to
fi
Include stable and predictable cash flows, being undervalued, having strong management, o ering cost-cu ng ff tti

achieve a 15- 0% IRR.

2
opportunities, requiring low capital expenditures (capex), and possessing a solid asset base for collateral.

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