Financial Due Diligence

The success rate of mergers and acquisitions increases exponentially if the buyer is well informed about the organization in question. Even when an investment firm decides to invest in an upcoming project or a new organization, they wish to know everything about the financial projections and other significant stats. The buyers or investors cannot entirely rely on the facts and figures presented by the sellers. It is where financial due diligence plays a key role.

Financial due diligence, also called accounting due diligence, is examining and investigating an organization’s financial records. This process usually precedes mergers, acquisitions, or investment deals. Financial due diligence provides the buyer/investor with a clear picture of where they are putting their money into. Transactions preceded by financial due diligence have a higher success rate than those that are not. Many organizations opt to outsource the preparation of financial due diligence reports to professional consultants or firms with considerable experience in providing auditing and advisory services.

What is the importance of financial due diligence?

Financial due diligence provides a buyer with the necessary assurance. It highlights the risks that the buyer may be taking investing in the target organization. It also helps the investors draft an appropriate contract that may shield them from any potential risks faced by the target organization. Financial due diligence ensures that there are no hidden skeletons in the closet and the reports presented by the target company are correct and fair. It also helps the buyers determine what to expect from the potential deal or transaction.

What is the difference between an audit and financial due diligence?

An audit is the examination of an organization’s financial reports. It does include an understanding of specific material and operational aspects but usually does not go beyond these. On the other hand, financial due diligence is the examination of an organization’s financial reports, operations, property matters, legalities, taxation, corporate matters and penalties, accounting, and everything else related to the organization.

What are the steps involved in financial due diligence?

Financial due diligence is a lengthy process, and sometimes it can take months. It is carried out in several phases, and each phase involves multiple parties. The process of financial due diligence can be understood with the help of the following steps:

Overview of the target organization

  • Understanding the target organization and why the buyer wants to sell it
  • History of previous merger/acquisition attempts and reasons for their failure
  • Debts and liabilities of the target organization
  • Examining the financials, revenue, and profit-making
  • Evaluation of the assets and liabilities, including patents, technology, IT infrastructure, etc
  • Understanding the management or workforce, their compensation, incentives, and company policies

Market Strategies and Clientele

  • Understanding the consumer base or clientele
  • Ruling out the competitors, comparing their profits
  • Knowledge about the franchises, distributors, and sales representatives
  • Current projects or tenders
  • Production capacity and customer backlog

Legalities and other issues

  • Information regarding an ongoing or historical legal issue
  • Ongoing environmental claims, permits, or any contractual obligations to the issue
  • Knowledge about the subsidiaries and associated organization

Understanding the complexities of the deal

  • Assessing the gains that will come from the deal
  • Evaluating the risks, both long term, and short term

What comprises the financial due diligence report?

The contents of a financial due diligence report may vary according to the buyer or investor’s needs. However, a formal financial due diligence report consists of the following:

  • Audited financial statements for the last fiscal year
  • Analysis of the financial reports
  • Overview of the target company and its workings
  • Competition analysis and profit margins
  • Comparison between the forecasted and the actual performance of the target company in the past years
  • Detailed analysis of the capital expenditure in the last fiscal year
  • Risk assessment report
  • A summary report with all the findings and opinions

Summary

Financial due diligence helps potential buyers or investors evaluate the factors that can affect an organization’s performance. It helps them make an informed decision and smoothens the negotiations. Also, being a third-party opinion, financial due diligence reports can be trusted by both parties. Opting for financial due diligence before any crucial deals prevents any potential issues that can come up in the future. Therefore, it becomes imperative to choose an experienced professional service provider for preparing the financial due diligence report because of its complexity and importance in the overall process.