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MBA Mondays: Financial audits

auditOn Mondays, sometimes I like to discuss business topics when I have the chance.

MBA Mondays is an idea I got from Fred Wilson.  The issue this Monday is financial audits. I have been thinking about audits recently, since we spend a lot of time going through them for deals that we work on.

See below for a few short tidbits on a financial audit.

What? A financial audit is an audit of a financial statement.  An audit means the verification of the accuracy (e.g. truth) and reasonableness of the financial statements.  The audits usually (but not always) result in an opinion band the opinion is intended to assure various parties that the financial statements are fair and that they give a fair view of the company based upon the accounting standards.

Are they a guarantee? No. An audit is intended to provide reasonable assurance, but it does not give a guarantee.

Who? Audits are usually done by audit firms. These are firms with licensed accountants who are experts in the field. They are almost always independent third parties.

Why? An audit (and the opinion) is intended to assure various parties that the financial statements are true and reasonable.  More specifically, it is intended to ensure that the company is not doing anything that is materially misleading its filings. This is why it is done by an independent third party.

Why does it matter?  These can be important in transactional work. In any sort of transaction, one company usually needs to be valued, because it is being sold or acquired, or its stock is being sold or acquired.  In order to value a company, a buyer and seller should understand things like assets and liabilities, cash and cash equivalents, property and equipment, and the short and long term debt of the company, among other things. Financial statements presented by the company have these numbers, thus the financial audit are important to help prove that the numbers the company gave are reasonably correct.

Layman’s Terms:  Think about it like your tax return.  You could purposefully put misleading information in to save money ever year. Moreover, even if you try to get it right, you may accidentally still get things wrong or mislead the readers. In many cases, the government will do an audit, to make sure what you submitted is correct.  That’s why tax firms will often audit the forms first, to make sure everything passes the test of reasonableness.

Keep in mind that this is the short version. The audits can become quite a bit more complicated than this.

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Tuesday, September 3rd, 2013 Business School, MBAMondays No Comments

MBA Mondays: EBITDA

EBITDAOne word I hear a lot in the finance world is EBITDA.  Most people don’t know how to pronounce that acronym, let alone how to define or calculate it.   But it’s quite an important concept in business.

Investopedia defines EBITDA as net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

EBITDA first became common in the 80s with respect to leveraged buyouts, because banks and finance firms used it calculate whether or not a company could service its debt, based on how much money it earned.

The simple way I like to think about EBITDA is earning power. It is the profit that a company earns for doing exactly what it’s supposed to: sell a product or a service.

EBITDA effectively removes the effect of things people don’t want to consider – the effects of taxes, interest income, and expense as well as the effects of capital investments e.g. depreciation and amortization.  In other words, EBITDA is a measure of a company’s financial performance sheltered from the real world since all companies actually are impacted by those.

Because EBITDA helps measure the company’s underlying profit, it is often very important.

Banks use EBITDA when determining how much money they can lend (e.g. if a company can service its debt).

Private Equity firms use EBITDA to compare companies across the world which have different capital structures.

M&A teams use it to come up with valuations for companies to acquire or sell.  These figures often go into their financial reports.

Lawyers and investment bankers use it to create earn-out provisions. An earn-out provision is an arrangement in which sellers of a business could receive an additional future payment (beyond the selling price), usually based on future earnings or the satisfaction of other conditions. (This term deserves more explanation, stay turned for a future post on this).

Executive compensation consultants use EBITDA to help determine long-term incentives of executives and CEOs.  The higher EBITDA is, the higher the incentive payment the CEO receives.

The list goes on and on.  It’s probably worth learning more about this important term if you want to succeed in finance.

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Monday, July 1st, 2013 Business School, MBAMondays 1 Comment

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Jeremy C Wilson is a JD-MBA alumni using his site to share information on education, the social enterprise revolution, entrepreneurship, and doing things differently. Feel free to send along questions or comments as you read.

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The contents of this blog are mine personally and do not reflect the views or position of Kellogg, Northwestern Law, the JD-MBA program, or any firm that I work for. I only offer my own perspective on all issues.
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