In this video you will learn how to build a template for the purchase price accounting required in an LBO model. I like to emphasize that an LBO model and a three-statement model are similar with a few exceptions. One primary difference, however, is the need to record a transaction. As it relates to this discrepancy, the two most common approaches I see create frustrating model-building challenges that we will elaborate on before diving into the template provided as part of this lesson.

The first approach I was taught was to have the three financial statements on one tab, or even on three separate tabs, and then record the balance sheet adjustments on a separate worksheet. What I immediately found frustrating about this approach was the amount of duplicative entry it required: every time I needed to update the balance sheet, I had to make the update on both worksheets.

The second approach solved for duplicative entry by putting the balance sheet adjustments and the balance sheet on the same worksheet. In the image below the balance sheet adjustments sit between the historical period and the projected period. What I disliked about this approach was that I could not create a new worksheet and paste the values for any given line item across both periods (the historical period and the projected period) without a huge gap between them. This made analysis that required both periods and any related output pages frustrating to create. (Note: Imagine an output page for a monthly LBO model. If you were attempting to calculate trailing twelve-month (TTM) EBITDA, for example, you would have to create a new formula for each of the first 12 months of the projected period.)

The solution to both challenges, in my opinion, is to put the balance sheet adjustments either in front of the balance sheet or behind it. For an annual model either approach works, but for a monthly model I found it makes far more sense to put the balance sheet adjustments in front of the balance sheet largely because it eliminates the need to scroll across 84 columns (24 months of historical data + 60 months of projected data) every time you wanted to update the transaction. So, in this lesson we will build the framework visible below in front of the balance sheet.

The purchase accounting template provided in the workbook allows for two types of balance sheet adjustments: (1) pre-transaction adjustments and (2) transaction adjustments. It is certainly possible to include all of these adjustments in the same two columns, but I find it helpful to provide a separate array to record any balance sheet “clean up” required in advance of the transaction. 

The “clean up” refers to the adjustments made under the pre-transaction columns visible in the image above. In this transaction, the only pre-transaction adjustment is the amount of cash being swept by the seller, but it is certainly possible to have additional adjustments agreed to by both parties in advance of the transaction. Certain assets might be excluded from the transaction and certain liabilities might remain the responsibility of the seller post transaction (we will elaborate on this in a future lesson). Either way the balance sheet assumed by the buyer is hugely important. The stock purchase agreement will contain schedules that detail precisely which assets and liabilities are included in the transaction, and a proper LBO model should attempt to mirror these schedules. 

Next Step
In the next lesson we will build the sources and uses table, and the information contained in this table will then be linked to the balance sheet adjustments template to record the transaction in the last historical period of the LBO model.