CURRENT AS AT 28 AUGUST 2018
Continuing our series on audit, assurance and related services, in this month’s newsletter we explain what is a “financial due diligence”, its purpose and core benefits.
What is a due diligence?
A purchaser or investor in any future business target will want to know that what they are acquiring is worth the price they are paying for it.
Whilst valuations and market factors play a part in determining the price, how can a purchaser reduce the risk of making a poor business and commercial decision around the health and viability of its future acquisition target?
A properly advised purchase should seek to obtain comfort through vendor warranties, trial periods of observing the business operations, and importantly, conducting due diligence.
A Financial due diligence should be an absolute must for anyone considering acquiring a new business (whether it be by acquiring shares in the company or purchasing the business and assets alone).
A due diligence is not just useful when considering merger or acquisition decisions. It can also be useful in evaluating whether a business should dispose parts of its existing business or assets. A financial due diligence review is also key in determining investment requirements for funding and capital arrangements.
What does a financial due diligence involve?
A financial due diligence is NOT an audit. Whilst an audit is focussed on providing an opinion on the historical financial statements of an entity, a financial due diligence is more a report on factual findings with a much broader, macro scope.
A due diligence will cover not only a review of the historical financial information, but also have consideration for factors such as forecasts for the company and the reasonableness of such budgets and forecasts
An audit is designed to achieve a very specific result – to report on the truth and fairness of the historical financial results of a company.
A due diligence on the other hand is more qualitative and can be designed to investigate the operational trends and results, past, current and expected future results. This enables the user to gain relevance for any proposed transaction.
Whilst an audit is quite rigid in approach and scope, a due diligence is more flexible and is tailored to suit the nature of the transaction, and the size of the company, business or asset being acquired.
A financial due diligence would typically involve a review of the following areas:
- historical financial results and latest, current financial position of the entity
- review of the forecasts and budgets with commentary on their reasonableness and key assumptions;
- gaining an understanding of the working capital requirements of the business, pre and post the proposed transaction;
- review of employee entitlements and any other current or contingent liabilities;
- risks and opportunities that may be apparent from the proposed transaction;
- taxation implications including considering potential tax liabilities and structuring advantages;
- impact of the above matters on the valuation of the business target.
What can you expect to get out of a due diligence engagement?
The scope of the procedures conducted under a financial due diligence review can be fairly broad. Some of the factors and questions that may be addressed through an appropriately scoped review include:
- Validation around the reliability of the information from the vendor
- Understanding of whether the historical results are sustainable
- What is the potential of the business earnings going forward
- Impact of new or proper accounting on the proforma results presented – are the underlying numbers a true reflection of performance
- Immediate and future tax implications
- Synergies of going ahead with the proposed transaction
- How you need to prepare your business for the proposed transaction
- How has the valuation been determined and is it reasonable?
- What are the constraints and risks surrounding the acquisition which need to be factored into the decision to go ahead
- Key terms that need to be built into the purchase agreement
I want to know more…
There are significant risks in not evaluating the pros and cons of your proposed transaction and it would be worth your while (and relatively much cheaper) investing and engaging a qualified professional to conduct such a review rather than run the risk, and significant cost, of a bad investment decision.
Stanley & Williamson has a proven track record in conducting comprehensive, tailored due diligence exercises in an organised and informative manner. You will be presented with a succinct yet comprehensive report on the findings from the review so that you can make an informed decision about your proposed transaction.
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