Recognizing Manipulated Metrics That Distort Deal Value
By M&A Leadership Council

In M&A, growth metrics often shine brightest during due diligence. 

But what if that growth is a mirage? Artificially inflated financials can lure buyers into overpaying, misjudging synergies, or acquiring liabilities disguised as opportunities. 

Here are seven warning signs to watch for:

1. Revenue Recognition Games

Sudden spikes in revenue may be more about creative accounting than organic growth. Look for:

• Unusually high end-of-quarter sales.
• Aggressive recognition of future revenue.
• Excessive discounts or extended payment terms to close deals.

Tip: Scrutinize revenue timing and patterns. Compare them against industry norms to spot irregularities.

2. Channel Stuffing

This tactic involves pushing more products to distributors than they can sell, creating a temporary revenue surge. Signs include:

• Inventory buildup at customer locations.
• Rising returns or complaints post-deal.

Tip: Examine inventory turnover and distributor agreements for red flags.

3. Deferred Expenses

Some companies delay recording expenses to make margins look stronger. Be wary of:

• Low operating costs relative to peers.
• Deferred maintenance or underfunded obligations.

Tip: Evaluate expense trends over time and question any sudden drops.

4. Overstated Accounts Receivable

Receivables that outpace revenue growth may signal payment delays or uncollectible accounts. Warning signs:

• Rising days sales outstanding (DSO).
• Large, overdue receivables.

Tip: Age the accounts receivable and assess collection risks.

5. Underreported Liabilities

Shrinking liabilities can artificially inflate profitability. Look for:

• Off-balance-sheet obligations.
• Legal disputes, warranties, or environmental liabilities buried in footnotes.

Tip: Dig into legal and contractual disclosures for hidden obligations.

6. Unrealistic Growth Projections

Forecasts that defy market realities could be a smokescreen. Common red flags include:

• Projected revenue growth far exceeding industry trends.
• Dependence on unproven products or markets.

Tip: Test projections with sensitivity analyses and assess assumptions for realism.

7. Nonrecurring Income Masking Weaknesses

One-time gains, such as asset sales, can inflate earnings but don’t reflect sustainable performance. Indicators include:

• Significant earnings from asset disposals or lawsuit settlements.
• Minimal details on recurring revenue streams.

Tip: Separate recurring revenue from one-time gains to evaluate core profitability.

Final Thoughts

Artificially inflated financials can distort a deal’s true value, leading to costly surprises post-close. By recognizing these seven warning signs early, M&A professionals can avoid illusions of growth and focus on opportunities grounded in reality.

Consider joining us next month for "The Art of M&A® Due Diligence: Discovering Risk and Confirming Value in the Diligence Process" - a highly interactive virtual course where you can ask questions, come to conclusions, and find out how other M&A professionals make decisions. Feb 18-20, 2025 for three half-days, via MS Teams.  

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