If in the bottom of your squat, your back is rounded then this will most likely be to compensate for lack of ankle dorsiflexion. This means that your ankles are not bending far enough and your knees stay behind or above your toes while you want them to drop over the toes.
It could be that the muscles responsible for ankle dorsiflexion which are the muscles located in the front of your shins are weak, or it could be a lack of MMC.
It could be that your calves are tight, and you can test that by coming into the following position. You can see that the knees are dropping over the toes, and that’s what you want and an indication that you have the flexibility.
If one can’t reach the above position, then the problem is highly likely at the back of the lower leg. Stretches and massages will help improve this area. If you passed this test, then proceed.
Holding out the arms is not bad when done correctly. Usually, it is done to compensate for the imbalance created due to a lack of ankle dorsiflexion. The torso will want to fall backward and holding out the arms prevents this. However, when the back is straight, as demonstrated below, and it’s not done to compensate then it’s perfectly fine to keep the arms out.
The scapulae are active and the back is strong and rigid.
You know that you have created the strength in the muscles responsible for ankle dorsiflexion when you can keep your arms in and reach a good deep squat.
Another great way to test your bottom position in the squat is by holding on to a pole or other object that will prevent you from falling back. In that bottom position while holding on you then work to pull the knees forward and improve your form in the bottom of the squat.
The kettlebell Goblet squat is also a great exercise to include in your training to improve ankle flexibility and back strength.