Stub Period in model
Rather simple question but cannot find applicable information to address.
My PE fund are yield investors, rather than the typical buy and flip. Currently built an LBO model on an annual basis, but coming across an issue - which is as follows:
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Company YE is October, so have historicals for Oct-20 to Oct-23
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Forecast begins Oct-24 onwards
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However, unreasonable to say deal will close Oct-23 or Oct-24, so wanting to create a stub period for Mar-24.
IS is pretty simple, as I can just pro-rata by Oct-24 by the 8 months (Nov-23 to Mar-24) however my RE on BS and SCF looks off?
So question I kindly ask to you all is - if you want to create a closing period of Mar-24, how would you flow RE through (i think its just taking stub period opening + NI - dividends)?
(I tried creating two stub periods to solve my problem - one from Nov-23 to Mar-24, and another from Apr-24 to Oct-24, as the IS side should naturally sum to the full forecast for FY24, alongside SCF, but still looks off as my following periods ending cash is extremely low).
Ah, the classic stub period conundrum! When you're dealing with a stub period in an LBO model, you're right to think about pro-rating your income statement (IS) figures. But when it comes to retained earnings (RE) on the balance sheet (BS) and the statement of cash flows (SCF), you need to be a bit more meticulous. Here's how you can approach it:
Income Statement (IS): As you mentioned, pro-rate the Oct-24 IS by 5/12 to represent the period from Nov-23 to Mar-24.
Retained Earnings (RE): For the stub period, you would indeed start with the opening RE balance at Nov-23, add the net income (NI) from the stub period IS, and subtract any dividends paid during that period. This gives you the closing RE for Mar-24.
Statement of Cash Flows (SCF): This is where it gets a bit tricky. You need to adjust each section of the SCF for the stub period:
Ending Cash Balance: The ending cash balance on the SCF for the stub period becomes the opening cash balance for the next period (Apr-24 to Oct-24). Ensure that the cash flow from the stub period is accurately reflected here.
Double-Check Your Work: Make sure that your balance sheet balances after accounting for the stub period. If your ending cash is extremely low, revisit your assumptions and calculations, especially in the SCF. It's possible that there may be an error in the pro-rating or an overlooked cash flow item.
Remember, the key to handling stub periods is consistency and attention to detail. Ensure that all pro-rations and adjustments are made systematically across all financial statements. And don't forget to articulate your assumptions clearly – it's crucial for anyone reviewing the model to understand the logic behind the stub period adjustments.
Good luck with your model, and remember, practice makes perfect! Keep tweaking until your cash balances make sense and align with your fund's investment strategy.
Sources: 21 Finance Interview Questions and Answers, 1st Yr Banking Analyst Open for Questions, 21 Finance Interview Questions and Answers, https://www.wallstreetoasis.com/forum/investment-banking/need-help-with-cashflow?customgpt=1, Investment Banking Interview Questions - 15 Answers to Land the Job
Not sure the question but you need to make sure everything on your IS and SCF is prorata. Nothing special about a stub period; a regular IS is just a stub period of 12 months
I spent couple more hours on it last night, and fixed the stub period ( i think - new issue below lol)
bottom line question = how to treat BS (more specfiically, RE) and SCF for stub period.
i think issue im facing is on my treatment of the earnout - where i am treating as a contingent liability, so on my pro forma BS - have an earnout liability increasing by $x and goodwill increasing by same amount - but unsure if that is correct treatment? (BIWS had article on it saying that was the treatment but now my earnout is flowing through RE, and causing cash flows to be higher than i think they should).
Seems generally like the correct treatment as earnout is technically purchas price? Although you could theoretically model earnout as a bonus and have it reduce net income. Again, haha, what's the question? If it's treated correctly? I think BIWS is right.
Sounds like you may have it flowing out twice. If it's coming out of P&L then you wouldn't hit your assets, only RE. If RE, then no increase to assets. Can't have a dual effect.
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