Following on from our recent Due Diligence article [and if you missed that one, check it out here], we delve further into the Due Diligence process and take a look at what the Financial Due Diligence looks like. We’ll also look at things you should be aware of when looking to acquire/expand your business or product line.
Due Diligence is an investigation into the business or product you are interested in purchasing.
To recap from our previous article… put simply Due Diligence is an investigation into the business or product you are interested in purchasing. Due Diligence allows the purchaser to investigate the business and confirm exactly what it is they are purchasing. It looks at key issues of the business/product including profits, financial risks, legal issues and potential deal-breakers. In doing so, the Financial Due Diligence can provide a purchaser with greater comfort and understanding of the financial drivers of the business and historical cashflow.
This area of Due Diligence may be very extensive or less so depending on your risk appetite. Typically, there are a few things to look at here, including:
Reconcile the management accounts of the business against the accountant’s financials. Look for any variances and ensure those variations can be explained;
debtors & creditors
Review the ageing profile of debtors and creditors, because this has a large impact on the working capital. You want to know how much money is outstanding, on what terms the money is paid. You also want to get a sense of any risks around that customer portfolio from a financial perspective;
cash flow profile
Start by looking at the bank statements of the business’ trading account on a monthly basis. Go back one to two years to see the flow of funds in and out of the business to determine how it has tracked from a cash flow perspective;
identify trends and anomalies
Review business/trading trends and importantly to identify any non-reoccurring revenue. A purchaser will need to understand if the performance of the business is subject to any one-off non-reoccurring revenue lines. This investigation will also assist a potential buyer to identify a high-value customer. This may lead to a detailed review of their engagement agreements.
Finally, look at a range of tax due diligence aspects. These relate to making sure the business has met its taxation liabilities correctly over the years and look at the Business Activity Statement [BAS] to match them up against reported sales and expenses.
Due Diligence helps investors and companies understand the nature of a deal, the risks involved and whether the deal fits with their overall strategy. Essentially, undergoing Due Diligence is like doing “homework” on a potential deal and is essential to making informed investment decisions.
Looking at purchasing a business, business assets or shares in a company? Then get in touch with a commercial lawyer at businessDEPOT Legal to find out what you should do next.
Please click on this link and download our checklist to check out the other areas to consider when conducting a financial due diligence investigation on a company sale transaction.
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