Crucial KPIs for valuating companies before purchase

Assessing a company’s financial health before an acquisition is a critical step and requires a rigorous analysis of various financial indicators (KPIs). These provide a clear view on the performance, profitability, and sustainability of the business operation. In this article, we cover the main KPIs that no responsible investor or manager can ignore before making a purchase decision.

1. ROA – Return on Assets

ROA measures a company’s ability to generate a profit from its total assets.

• Formula: Net Income ÷ Total Assets
• Interpretation: A high ROA indicates that the company efficiently uses its resources to generate profits.
• Relevance: Helps to realize the overall profitability of the asset structure, crucial in capital-intensive companies.

2. ROE – Return on Equity

ROE valuates the return on equity invested by shareholders.

• Formula: Net Income ÷ Equity
• Interpretation: A high ROE is a sign of good management and solid financial performance.
• Relevance: Essential for investors who want to assess the potential return on investment.

3. EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization

This indicator measures the company’s operating performance before financial and accounting charges.

• Formula: Operating Income + Depreciation + Amortization
• Interpretation: EBITDA allows you to compare companies with different capital structures and tax policies.
• Relevance: Fundamental to assess the cash generation capacity of operations.

4. Profit Margin

Profit margin represents the percentage of revenue that translates into net profit.

• Formula: Net Income ÷ Total Revenue × 100
• Interpretation: A high margin suggests cost control and operational efficiency.
• Relevance: Indicates the actual profit and helps to perceive the sustainability of the business.

5. Other relevant KPIs

In addition to the leading indicators, there are other KPIs that complete the analysis:

       a) Current Ratio

• Formula: Current Assets ÷ Current Liabilities
• Objective: To assess the company’s ability to meet obligations in the short term.

       b) Debt Ratio

• Formula: Total Liabilities ÷ Total Assets
• Objective: To measure the level of financial risk and dependence on external financing.

       c) Operating Cycle and Cash Cycle

• Allows you to understand the time needed to convert the invested resources into available cash.

       d) Inventory Rotation

• Valuates the efficiency in inventory management and impact on the company’s liquidity.

       e) Profit Retention Ratio

• Analyzes the percentage of profits reinvested, revealing management’s long-term vision.

In short, before moving on to the acquisition of any company, it is essential to cross-reference these indicators with a qualitative analysis of the strategy, market position, organizational culture and sectoral risks. An informed decision requires both financial and strategic vision. These KPIs are the keys that unlock the vault of true business value. Neglecting any of them can jeopardize the success of the acquisition.

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