How would you adjust the Income Statement in an LBO model?

The most common adjustments:

• Cost Savings – Often you assume the PE firm cuts costs by laying off employees, which could affect COGS, Operating Expenses, or both.

• New Depreciation Expense – This comes from any PP&E write-ups in the transaction.

• New Amortization Expense – This includes both the amortization from writtenup intangibles and from capitalized financing fees.

• Interest Expense on LBO Debt – You need to include both cash and PIK interest here.

• Sponsor Management Fees – Sometimes PE firms charge a “management fee” to a company to account for the time and effort they spend managing it.

• Common Stock Dividend – Although private companies don’t pay dividends to shareholders, they could pay out a dividend recap to the PE investors.

• Preferred Stock Dividend – If Preferred Stock is used as a form of financing in the transaction, you need to account for Preferred Stock Dividends on the Income Statement.

Cost Savings and new Depreciation / Amortization hit the Operating Income line; Interest Expense and Sponsor Management Fees hit Pre-Tax Income; and you need to subtract the dividend items from your Net Income number.