If you had to pick one statement to look at, which one would it be an why?
Statement of cash flows because it gives the clearest picture of a company’s true financial health and value generation.
In M&A, cash flow is even more critical because it underpins valuation models (DCF, LBOs, and synergy analyses) and determines how much leverage a combined entity can safely support.
Walk me through the 3 Financial Statements.
The balance sheet shows a company’s assets, its liabilities and shareholders’ equity. The income statement outlines the company’s revenues and expenses. The cash flow statement shows the cash flows from operating, investing and financing activities.
What is Free Cash Flow
Free cash flow is the cash a company generates after paying for CapEx and working capital — it’s what’s left to repay debt or return to shareholders.
What is the Statement of Cash Flows?
The cash flow statement showcase the cash generated and used during a given period of time. The various activities that are involved the Cash Flow statement are:
Operating activities – business activities accounting to cash
Investing activities – sale and purchase of equipment or property
Financial activities- purchase of stock and own bonds
Supplemental information- exchange of significant items that don’t involve cash
How is the income statement linked to the balance sheet?
Net income flows into retained earnings.
Revenue and expenses also affect working capital accounts like A/R, inventory, and A/P, while non-cash items like depreciation reduce PP&E.
If you could only have two of the three main financial statements, which would it be?
The balance sheet and income statement because as long as I have the balance sheet from the beginning and end of the period as well as the end of period income statement, I would be able to generate a statement of cash flows.
What are some potential reasons that a company might acquire another company?
Revenue and Cost Synergies
Upselling/Cross-Selling Opportunities
Proprietary Assets Ownership (Intellectual Property, Patents, Copyright)
Expanded Geographic Reach and Customers
Revenue Diversification and Less Risk
Horizontal Integration (i.e. Market Leadership and Less Competition)
Vertical Integration (i.e. Supply Chain Efficiencies)
How do you model revenues for a company?
There are three common ways to forecast revenues: bottom-up, top-down, and year-over-year.
A bottom-up approach to financial modeling involves starting with individual products/services, estimating average prices/fees per product or service and then growth rates.
A top-down approach involves starting with the overall market size, estimating a company’s market share, and then translating that into revenue
A year-over-year approach involves taking last year’s revenue and increasing it or decreasing it by a certain percentage.
How do you model operating expenses for a company?
When modeling operating expenses, I start by understanding the company’s cost structure — which expenses are fixed versus variable, which scale with revenue, and which are discretionary or strategic.
I model each with specific drivers: marketing tied to revenue or CAC, R&D to product plans, and G&A to headcount or inflation. That way, expenses scale logically as the business grows.
How Do the Financial Statements link together?
Net income from the income statement flows to the top of the cash flow statement and into retained earnings on the balance sheet.
The cash flow statement adjusts net income for non-cash items and changes in working capital, producing the change in cash that updates the balance sheet. Every activity — like depreciation, CapEx, or debt issuance — links at least two statements, ensuring everything reconciles.
What makes a good financial model?
A good financial model is accurate, transparent, and decision-focused. It clearly links business drivers to results, separates inputs and calculations, and flexes easily for different scenarios. Most importantly, it tells a story — helping management see how operational choices translate into value. A great model isn’t just technically sound; it’s strategically useful.
What is Sensitivity Analysis in Financial Modeling?
Sensitivity analysis tests how changes in key assumptions — like growth, margins, or discount rate — affect valuation or deal outcomes.
It helps quantify risk and identify which variables matter most. I use it to show management a range of outcomes — best, base, and downside — so we can make informed decisions under uncertainty. It turns a static model into a strategic tool.
What is Scenario Analysis in Financial Modeling?
Scenario analysis tests how the business performs under different combinations of assumptions — base, upside, and downside. Unlike sensitivity analysis, which changes one variable at a time, scenario analysis changes several together to model realistic situations. It helps quantify uncertainty and guide strategic decisions.
In M&A, this helps answer questions like “What happens if synergies come in six months late?” or “How much leverage is still safe if margins compress?”
How do you forecast Costs?
You can forecast costs a couple of ways:
Percentage of Revenues - This is probably the simplest way to do it, but it doesn’t provide insight into things like fixed costs.
Variable Costs base on Revenue and Fixed costs based on historical trends.
Is it possible for a company to show positive cash flows but be in grave trouble?
Yes — a company can show positive cash flow and still be in serious trouble if the cash isn’t coming from sustainable operations. For example, they might be selling assets, raising debt, or cutting CapEx to generate short-term cash.
That’s not true profitability — it’s financial triage. The key is to look at the source and quality of cash flow, not just the headline number.
Why do capital expenditures increase assets (PP&E), while other cash outflows, like paying salary, taxes, etc., do not create any asset
Capital expenditures are capitalized because of the timing of their estimated benefits – the lemonade stand will benefit the firm for many years.
The employees’ work, on the other hand, benefits the period in which the wages are generated only and should be expensed then.
How do you evaluate working capital in a deal?
I analyze historical trends in receivables, inventory, and payables to establish a normalized working capital target.
This target becomes a key negotiation point in the purchase agreement.
Post-close, any deviation can result in adjustments — so I ensure it’s grounded in consistent operating assumptions.
How do you model working capital in a transaction?
I start by analyzing historical trends in AR, inventory, and AP to establish normalized levels relative to sales. From that, I calculate working-capital turnover ratios and determine the average percentage of revenue tied up in each component.
In the forecast, I link AR, inventory, and AP to projected revenues using realistic days metrics (DSO, DIO, DPO). This makes working capital automatically scale with growth.
In an M&A context, I use those historical averages to negotiate a working-capital peg — the target level baked into the purchase agreement. Any deviation at closing results in a purchase-price adjustment, so accuracy here directly protects value.
I also model post-close improvements — for example, tightening collections or optimizing inventory — as part of synergy planning.
Working capital is often overlooked, but it’s one of the biggest drivers of free cash flow, so I treat it with the same rigor as EBITDA.
What is a working capital peg?
A working capital peg is the target level of normalized working capital that’s agreed upon between buyer and seller in an acquisition.
The purpose is to ensure the buyer receives a business with a “normal” level of current assets and liabilities at closing — not one that’s been drained of cash, inventory, or receivables right before the deal.
If the peg is $20M and actual working capital at close is $18M, the purchase price is reduced by $2M — because the buyer received less working capital than expected.
Walk me through the WC Days Metrics
Working capital days show how long cash is tied up in operations.
Days Sales Outstanding (DSO) measures how quickly you collect from customers
Days Inventory Outstanding (DIO) how fast you move inventory
Days Payment Outstanding (DPO) how long you take to pay suppliers.
Together, NWC Days = DSO + DIO – DPO. Lower is better because it means faster cash conversion.
In M&A, these metrics directly impact FCF and Enterprise Value (modeling). They can also be an important source of synergies.
Which valuation method is most common today?
The most common valuation method today is comparable company analysis. It’s fast, market-based, and reflects real-time investor sentiment through trading multiples like EV/EBITDA.
Precedent transactions and DCFs are still used for triangulation, but Comps usually drive the valuation range used in negotiations and fairness opinions.
Comps are less reliable, so I apply private company or size discounts. Precedent transactions become more important since they reflect real deal pricing. And I often lean on DCF to capture fundamentals when market data is thin.
