Course 2: Financial Statement Normalization & 3-Statement Modeling for Acquisitions
Course purpose
An acquirer does not purchase a tax return or an adjusted-earnings presentation. The acquirer purchases an operating organization with customers to serve, people to pay, equipment to maintain, and financial obligations to meet. This course teaches how to reconstruct that organization's recurring economics from imperfect small-business records and express the result in a dynamically linked financial model.
The six chapters form a collegiate textbook sequence. Each contains sustained explanation, worked numerical examples, reconciliations, beginner-trap callouts, and a self-study problem set with detailed solutions. The sequence builds from accounting recognition through tax forensics and earnings normalization to a two-year operating forecast and acquisition decision memorandum. The final capstone uses Vanguard Industrial Machining, a fictional manufacturer with $4.5 million annual revenue.
Intended reader and prerequisites
The course is designed for a professional who understands basic financial-statement vocabulary but has not conducted acquisition diligence or built an integrated model. Familiarity with assets, liabilities, revenue, expenses, and spreadsheet formulas is sufficient to begin. Course 1's distinction between net income, operating cash flow, unlevered free cash flow, enterprise value, and equity value provides helpful context.
Complete the chapters in order. Learners who have already built valuation models should still work through the accounting and tax examples: a mechanically sophisticated DCF cannot repair unsupported historical earnings. No proprietary software, paid course materials, or CFI enrollment is necessary. Use Excel, LibreOffice Calc, or a comparable spreadsheet application.
Allow approximately 24–30 hours, including reading, reproducing examples, solving problems, and completing the capstone. The text is intentionally more extensive than a transaction checklist. Its purpose is to develop explanations that remain useful when a seller's records differ from the examples.
Syllabus and chapter navigation
| Module | Chapter and central question | Practical work product | Suggested time |
|---|---|---|---|
| 1 | Demystifying Small Business Accounting: Cash vs. Accrual & QuickBooks Reality: What economic activity do the records actually measure? | Cash-to-accrual bridge, cutoff analysis, and source mapping | 3–4 hours |
| 2 | Tax Return Forensics: Reconciling Form 1120-S & Schedule C to Internal Financials: Why can tax profit and book profit differ legitimately? | Book-to-tax reconciliation and entity-aware earnings bridge | 4–5 hours |
| 3 | The Anatomy of Add-Backs: SDE vs. Adjusted EBITDA Demystified: Which costs disappear, and which must be replaced? | Evidence-backed SDE and managed-EBITDA normalization | 3–4 hours |
| 4 | Quality of Earnings (QoE) Self-Defense: Defending and Haircutting Add-Backs: How much confidence should a buyer place in each claim? | Adjustment register, challenge scenario, and findings memo | 4–5 hours |
| 5 | Constructing the Normalized 3-Statement Operating Model: How do recurring earnings become operating cash and ending balances? | Integrated statements, schedule roll-forwards, and dynamic checks | 5–6 hours |
| 6 | Course 2 Capstone: Normalizing Vanguard Industrial Machining: Do the reconstructed earnings support a liquid, transferable operation? | Two-year model, downside case, evidence register, and acquisition memorandum | 5–6 hours |
Learning outcomes
By completion, the learner should be able to explain why legitimate accounting-method differences, tax choices, errors, and owner incentives produce conflicting pictures of profit. That explanation should distinguish legal tax planning from false reporting and avoid presuming that every small-business owner manipulates records. The learner should also recognize how a sale process can reverse incentives, encouraging aggressive earnings adjustments after years of emphasizing deductions.
The learner should be able to reconcile receipts, receivables, customer advances, inventory, prepayments, payables, and accrued expenses without double counting. A correct reconciliation identifies the affected period and keeps accounting corrections separate from economic normalization and buyer initiatives. An unexplained difference remains visible rather than being forced into an arbitrary adjustment.
The learner should be able to interpret an S-corporation or sole-proprietor reporting perimeter, identify relevant tax-return schedules, and construct a supported book-to-tax bridge. This competence includes understanding why tax depreciation is not a second EBITDA add-back, why shareholder distributions differ from officer compensation, and why proprietor labor can be absent from deductible expenses.
The learner should be able to define SDE and adjusted EBITDA explicitly, price required replacement labor, test personal-expense claims, normalize non-arm's-length rent, retain recurring repair costs, and correct unsupported inventory. Each accepted adjustment should identify its source, recurrence, replacement cost, and effect on the operating model.
Finally, the learner should be able to link net income to operating cash flow, cash investment, financing movements, ending cash, and a balanced financial position. A completed model must respond coherently to slower collections, additional capital spending, new borrowing, and distributions. It must also flag insufficient cash even when assets equal liabilities plus equity.
Shared case conventions
Course 2 uses actual US dollars throughout, overriding the $000 shorthand used in some other courses. Parentheses in statement tables indicate deductions or liability presentation where the context specifies it. Keep full precision in formulas and round only display values.
Early chapters contain standalone conversion and tax examples. The recurring normalization base introduced in Module 3 is reported EBITDA of $540,000, corrected historical EBITDA of $500,000, and normalized managed EBITDA of $616,000. Module 4 presents a separate evidence-challenge scenario of $565,000; it does not silently replace the base case. Modules 5 and 6 use the $616,000 base and a corrected opening balance sheet of $2,240,000 total assets.
Historical Vanguard accounts assume an S corporation without recorded entity income-tax expense in the examples. The integrated forecast uses an explicitly hypothetical prospective cash-tax convention of 25% of positive pretax income. This is a modeling assumption, not a tax conclusion about the historical company or a recommended acquisition structure. Applicable tax treatment requires transaction-specific advice.
Study method and assessment
Reproduce each worked example before reading the problem solutions. Write a short explanation of every sign: why an asset increase consumes cash, why a payable increase supplies cash, and why a distribution changes equity without changing operating earnings. If a formula cannot be explained economically, inspect it before proceeding.
Maintain one workbook with separate source, history, correction, normalization, forecast, and check sections. Preserve the seller's reported figures rather than overwriting them. Keep an evidence register that distinguishes verified facts, seller claims, buyer assumptions, conditional conclusions, and unresolved questions.
The final capstone provides a 100-point rubric. Self-assessed completion requires at least 80 points and all critical mechanical checks: no unexplained balance-sheet difference, cash plug, duplicated inventory correction, or concealed minimum-cash breach. A supported recommendation to revise or decline a transaction can earn full credit. This independent curriculum does not confer a CFI credential.
Sources and scope
Chapter 1 links primary Intuit guidance on inventory reporting. Chapter 2 links IRS instructions for Form 1120-S and Schedule C; the capstone returns to the 1120-S reference. Consult the relevant filing year's complete instructions and attachments for real work. Sources establish reporting context, while all case figures, forecast terms, and exercises are original teaching assumptions.
This course extends the public modeling-topic alignment described in Sources and CFI Alignment. It is independently authored, not an official CFI course or a substitute for a scoped professional QoE engagement, legal review, or tax advice. Its practical purpose is to make an acquirer better able to ask questions, assess evidence, and understand the model supporting a purchase decision.
Course 1 overview · Begin Module 1 · Course 3 overview
Construction resources and completion
Use the learner workbook, student assignments and graded capstone packet. Compare only after completing your attempt with the instructor workbook and capstone solution.
- Complete all six independent module assignments.
- Construct the linked model and explain a controlled assumption change.
- Submit the capstone memorandum and evidence register.
- Achieve 80/100 and resolve all critical checks, including any funding or liquidity failure.
See the learning path for units, instructor/student distinctions and verification limits.