Private equity firms are ready to invest vast amounts of money in a company, but they also expect to pay for something that’s going to bring higher revenues in the future and eventually enable them to sell the company.
That’s precisely why their decisions are driven by the numbers, which is why they have a few key metrics they want to see:
- Liquidity
- Cash flow
- Expense control
- Analysis of each product
- Industry related metrics
Before we go into greater detail on each one, there are few other important things you should be aware of.
The first thing that most investment companies do when they invest in or purchase a company is to improve further and develop the company’s information systems. They do that to ensure that two key things are up to their standards:
- The costs – what they are and where they are. If everything is according to their set of rules, nothing changes. However, if the costs can reduce, you can be sure that they will do everything they can to achieve this. Private equities only want their investments to pan out, which is inherently suitable for both the private equity investor and the company in which they invested.
- Which products and services are selling – this again is tied to the revenues of the company. Whatever product or service the company has that is creating incomes for them, will remain the same or improved. However, this is not always the case. The private equity firm will want to cut down on costs like we already mentioned, and one of the ways to do that will be to eliminate the products or services that are not producing high-enough revenues.
All of this will enable the investor to increase the worth of their investment and eventually sell the company to another, larger buyer and make a profit.
Before the investor buys a company, they want to find out about the five main metrics we previously mentioned, so let’s dig into each one and explain in more detail.
1. Liquidity
The company’s liquidity measures to how quickly it can be bought or sold without affecting its price are the reason why liquidity matters to an investor are clear.
A controller, CFO, or a bookkeeper would typically be responsible for this metric, although it is not looked into with such a degree the investor would want. That’s why liquidity usually becomes an issue after the company is sold or invested in. When that happens, the private equity firm wants regular cash flow models for specific time periods:
- Daily – if there is a crisis at the moment,
- Weekly,
- Monthly,
- Or quarterly.
It further necessitates the need for top-notch accounting solutions because the company needs to make sure that the liquidity metrics remain at the desirable levels or change to something the investor wants.
2. Cash flow
Income matters and the investors know that. No one wants to invest in or own a company that’s not making enough money. However, even though the investors care for it, they care more about the cash flow.
The reason behind this is apparent. Income statements include non-cash revenues and expenses, while cash flow statements clearly show how much cash the company is generating. This single metric matters a lot to investors as high incomes sometimes do not necessarily mean that the money is flowing.
Now, investors value companies on EBITDA, which is the leading indicator of a company’s financial performance and earnings potential. It’s an acronym, and it includes:
- Earnings Before Interest,
- Taxes,
- Depreciation, and
- Amortization.
All in all, not all values are equal to investors, and increased EBITDA is what’s going to enable the investor to sell the company later for a lot more than the amount they invested.
3. Expense control
Investors always pore over expenses, which is why spending controls are another crucial metric they want to know about.
This metric is used to identify and reduce the expenses a company has, which in turn increases profits. It starts with the budgeting process where real results compare against the budgeted expectations. If it happens that the costs are higher than they were previously planned to be, action has to be taken to lower them.
That’s why investors always ask about:
- The company’s policies
- Why specific expenses are spiking
- How these expenses are controlled
4. Analysis of each product
Cost accounting is often tricky, even for larger companies, as sometimes it’s easy to omit certain areas where profits are made, and cash is generated. That’s why costs need to be controlled in the best way possible.
When things are omitted, investors always want to do a thorough analysis of each product, to see the actual margins for each specific product their target company is making.
When it comes to businesses offering services instead of products, the private equity investors look into how contracts are bid, and they want to avoid deals that aren’t profitable enough, even though they increase revenues.
5. Industry-related metrics
The fifth and last metric is hard to explain as it’s different for each company, depending on what business they are in. Every industry has its key metrics, which is why each company needs to define them and research into the parameters used by other companies in their industry.
The private equity firm will undoubtedly want to check these metrics as they help them gain insight into how the company is performing within its industry, not just how it’s fairing overall.
These five metrics are the backbone of the way private equity firms see investment targets. That means that every company looking to attract investors’ needs to worry about them and work on improving them and eventually presenting them in the best possible light to the investors.
