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Why Is It Important To Conduct Financial Due Diligence?
Any merger and acquisition are happens after a lot of thought and planning. That’s where financial due diligence comes into play. Businesses take into account various parameters including, finances, resources, and other regulatory and statutory compliances.
A comprehensive investigation or “due diligence” are based on the historical and forecast operations, resulting in profits. However, the focus is generally on financial due diligence and that will be the primary focus of this piece.
Reasons Why Financial Due Diligence is Crucial for Businesses
There is a misconception that in-depth investigation into the finances of the company, due diligence is a form of audit. That’s not correct. An audit is basically a certification that include company’s financial statements reflect the true financial health of the company.
However, this activity goes a step beyond the stand of an audit. It evaluates reasons based on historical trends and forecasts, ensuring future performance of the firm.
There are no standards of due diligence methodologies. It varies between businesses and depend on the scale of acquiring company. Typically, emphasize on historical earnings comparing to the past such as interest, amortization taxes and depreciation, the value of net assets, debt and liabilities.
After assessing all these variables, a potential purchaser of a company should be able to evaluate and know about any factors that might act as deal breakers or whether the price of the acquired company is appropriate and show the true worth of the company.
The time for financial due diligence
Analysis of the financial position should be a matter of concern whenever a possible buyer is considering an acquisition of a business. Begin the process as soon as you develop interest before the seller or a letter of intent detailing out the terms of the transaction. So, ensure that the purchaser and the seller agrees upon. The process should go on simultaneously along with the negotiations.
Generally, the whole procedure should take between two to four weeks. However, it depends on the size of the company you are acquiring and the nature of work.
Who can conduct this activity?
There are a number of options here. Delegate the investigations into the financial health to the acquirer’s own team of audit and accounting experts. You can also outsource to an external team of professionals who have a high degree of expertise in this field. Most purchasers opt for external agencies because of some inherent benefits. These include –
- Getting an independent and unbiased opinion from those who have no stake in the transaction
- Done by experts who fully understand the intricacies and dynamics of M&A environment
- Utilize internal resources better for the planning of necessary transactions after the deal is lock.
Information required for evaluation
Here too the reports and documents required for carrying out financial evaluation is not standardized. It is dependent on the abilities of the company being acquired to generate financial reports accurately.
However, the mandatory reports that form part of the procedure include business plans and budgets, current financial statements, trial balances, general ledger, comprehensive management reports and state of the accounts, latest operating results, and projected financial analysis of accounts.
Answers provided by financial due diligence
The reason for carrying out this process is to get answers to a lot of questions about the financial health of the target company. These include –
- Checking whether all the records provided by the seller is accurate in all respects
- Whether the historical revenue and earnings will be sustainable in the future too
- Whether the company has invested to the maximum extent possible in capital expenditure
- Checking for any liabilities that should be taken into account but not reported.
- The potential future earnings of the company warranty
- The quantum of working capital requirements at transaction closing
- Whether the company has future commitments and contingencies
All these will enable the purchaser to know whether a fair price is being paid that reflects the true state of the financials of the company. It also helps to determine if the necessary guarantees have been made a part of the final agreement and whether all issues have been addressed and included therein.
Further, in the present business environment of uncertainties that prevail the world over, it is necessary to carry out a detailed analysis before investing in the purchase of a company. The amount invested for financial due diligence far exceeds the ultimate loss that might have to be incurred for a bad acquisition.
Taking the help of professional agencies
It is very clear now that financial due diligence plays a very important part in any M&A process and that it should be outsourced to expert and professional services with long years of experience in this field. Only they will be able to carry out a detailed evaluation of the financials of the company, a crucial prerequisite for understanding the state of the finances of the targeted venture.
A leading company in the field of financial due diligence accounting services is Cogneesol. We have been offering top-level accounting outsourcing services to our clients all over the world and hence our accountants are well conversant with this process. All reports typically required for due diligence are routinely prepared by us on behalf of our clients, most of whom fall in the Fortune 500 category.
Hence we are eminently qualified to offer financial due diligence and accounting services and have done so for many of our valued clients.
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