Financial Due Diligence focuses on establishing a factual and historical foundation of Company. Financial Due Diligence not only reviews the historical foundation of the Company but also gives an expert and financial opinion about the future of the Company. Any person while investing or selling or buying or as routine check-in affairs of Company conduct Due Diligence process in the Company. Any person doing business always wants to be sure about the future profitability of the business in the market, so this Due Diligence process is conducted in the Companies. In the article, we will discuss the objectives, importance, methods, and benefits of Financial Due Diligence.
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What is Financial Due Diligence?
FinancialDue Diligence is a process which involves an investigative analysis of thebusiness of Target Company, and also assessing the critical financial issuesfacing the cash flows and business of the Target Company. Due Diligence isusually performed when any person wants to acquire a Company. The acquirer, inthis case, needs some certainty regarding the financial status of the Company. Theprocess of Due Diligence is conducted into the Company to look into the keyissues facing the Company’s financial business. Furthermore, to identify thekey financial risks and potential deal breakers of the financial transactionsof the Company.
DueDiligence is not only conducted when there is buying or selling or investing inCompany. The owner of the Company sometimes sits and investigate the financialbooks of the Company as a routine check of the financial status of the Company.
It is essentialto do a financial analysis of the Target Company. The acquirer needs to bealways ensured and understand what risks are existing in the Company. Thepurchase of assets means that the historical financial and legal responsibilityof Target Company is not transferred to the acquirer. Hence, it can besaid that the Due Diligence is process is less extensive and much shorter thanthe other transactions like when any Company acquires shares. However, itis not valid in all circ*mstances and cases.The acquirer should always be sure about the future earning of theTarget Company. So to deal with it, the acquirer should always determine thevalue drovers of the future earnings of Target Company and should always beassured that the gains will always be sustainable in the future.
What are the Objectives of Financial Due Diligence?
Theprocess of Financial Due Diligence is much more than a simple checklist of theprocedures of the Company.The main objectives are as follows:
- To Check andreveal any financial risks related to the Company;
- To understandthe historical financial situation of the Company;
- To check the correctnessof the numbers of the Company;
- To understandthe Target Company’s balance sheet;
- To understand TargetCompany’s profit and loss;
- To go forfurther price negotiations and opinions on the purchase price;
- To forecast theTarget Company’s future financial situation;
- To formulate post-takeoveracquisition plans and integration program;
- To calculate thefinancial risks and avoid such financial risks of Target Company.
What are the Fundamental Principles of Financial DueDiligence?
The process of conducting Financial Due Diligence is different from the general audit work of the Company. Hence, still, the persons participating in the Due Diligence process must adhere to the following fundamental principles:
Principle of Independence
Underthis principle, the financial consultancies and the financial professionalsconducting the process of Financial Due Diligence are the two elements that arecovered. The Financial consultancies and the financial professionalsconducting the process of Due Diligence should not be in any means connectedwith the Target Company. There should be not any direct or indirecteconomic interests of the financial consultancies, and financial professionalsshould be involved with the concerning Target Company.
Principle of Prudence
Thefinancial consultancies and the financial professionals conducting the processof Due Diligence in the target Company should hold a prudent and professionalapproach throughout the time the process is being conducted in the TargetCompany. A properreview of the work plans, working papers, staff allocation, and report of DueDiligence should be done by the financial consultancies and financialprofessionals involved in the process of Due Diligence.
Principle of Comprehensiveness
ThePrinciple of Comprehensiveness the review of all sides and aspects of all itemsand areas related to Financial Statements should be done by the financial consultanciesand financial professionals conducting the process of Due Diligence in theTarget Company. A check, especiallyon the hidden liabilities of the Target Company, should be done by thefinancial consultancies and financial professionals.
To conduct aproper Due Diligence process in Target Company and to provide benefit toacquirer proper planning, strategy, technique, and procedures should befollowed as per relevantprofessionalstandards to achieve the goalset by financial consultancies and financial professionals at the time ofengagement in the process of Due Diligence.
Principle of Materiality
The financial professionals and the financial consultancies conducting the Due Diligence process in Target Company use some level of risks while performing the financial review of the Target Company. The levels of risks involved should be an analyst at the risk assessment stage. The materiality principle set some materiality performance for the financial consultancies and financial professionals and some sort of tolerable errors which the consultancies and professionals can accept later on. The word done by the financial consultancies and financial professionals should be able to sufficiently and appropriately obtain evidence to prove their report to the acquirer. The report of this process of Due Diligence should possess the characteristic of verifiability.
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What are the Methods of conducting Financial DueDiligence?
There are a variety of methods to perform Financial DueDiligence in Target Company. Financial consultancies and financial professionals apply the following methods:
Reviewof Target Company
The financialconsultancies and the financial professionals do a thorough review of thefinancial statements and other financial materials of the Target Company. Thenthe critical and material financial factors of the Target Company areidentified.
Thereview should be conducted either internally, by the accounting and financedepartment of the acquirer or can be done externally by the financialconsultancies or financial professionals who conduct Due Diligence process indifferent Companies. The main benefit ofusing external financial consultancies and financial professionals is that thereview given by them is an independent viewpoint with no direct or indirectinterest from the outcome of the process.
ConductingAnalytical Procedures
Thefinancial consultancies and financial professionals conduct some analytical proceduressuch as analysis of performance, trend analysis, structural analysis of theTarget Company. The materials acquiredthrough all the channels of analysis are collected, and results are collated todiscover the critical issues and abnormalities related to the Target Company.
Interviewin Target Company
The primarymethod used for conducting Due Diligence is the interview in Target Company. Thereshould be sufficient communication between the financial consultancies andfinancial professionals conducting Due Diligence process with the internal hierarchyof Target Company, employees at different positions of Target Company andintermediary institutions related to the Target Company.
InternalCommunication
Thefinancial consultancies and financial professionals usually come from differentbackgrounds and specializations; hence, this makes mutual communication anessential element of the process of Due Diligence.The work results should also be shared timely for the more efficientaccomplishment of the investigative targets is an effective method forconducting the Due Diligence process in a Company.
WhatDocuments are required for Financial Due Diligence?
Thedocuments required for Financial Due Diligence are as follows:
- Copy of minutes of Board Meetings, General Meetings, and any other Meetings;
- Copy of notices of all meetings held in the Company;
- Copy of attendance sheet of all Meetings in the Company;
- Copy of Statutory Registers maintained by Company under the Companies Act, 2013[1];
- All the Filings made with the Registrar of Companies (ROC);
- A copy of the declaration of the Director’s interest in the Company;
- Copy of all consent forms of shareholders for convening a Board or General Meeting;
- A list of all the cities and countries where the Company has business operations;
- Details of all the debentures or other securities the Company issued till date along with the debenture bonds or other documents related to the issue;
- All agreements containing veto rights, voting rights, right of first refusal, pre-emptive rights or other preferential rights to acquire securities;
- Agreement of rights to appoint nominee Director in Company;
- Agreement of any change in the foundation team of the Company along with all the filings made related to such change;
- The GST Registration of the Company;
- The table showing the issued, authorized and paid-up capital of the Company;
- The copy of sample share certificates, other securities, and options issued by the Company;
- Copy of any share transfer forms if executed by the Company;
- Any documentation or agreements relating to exchange, conversion, redemptions, repurchases, or similar transactions involving the securities of the Company.
What is the need to conduct Financial Due Diligence?
TheFinancial Due Diligence in Company is required so that the acquirer is wellaware of the essential considerations of the Target Company like:
- Ownershipand Management of Target Company
Thereshould be research is done on the ownership of Company, like, whoruns the Company, or if the founders still run Company?
- BalanceSheet Analysis of Target Company
Theanalysis of the debt-equity ratio of the Company should be doneof the Target Company by the acquirer. The debt of the Target Company shouldalso be checked. The target Company should never be in too much debt as it willaffect the future financial business of Target Company.
- Capitalizationof Target Company
Thecomparative analysis of both how vast and volatile is the marketand Target Company.
- Profit andRevenue Trends of Target Company
Therise, fall, and stability of any of the trends of Target Company are lookedupon to avoid any loss in the future.
- Risksrelated to Target Company
TheRisks specific to Companies and large industries are overviewed of TargetCompany. A check on the outstanding risks associated with TargetCompany is also done. The prediction related to some unforeseeable risks ismade to avoid future losses in the business of the Target Company.
- Expectationsfrom Target Company
Theacquire always expects a reasonable estimate of profits and financialgains from the Target Company. Hence the estimates are calculatedbeforehand by an acquirer to be sure about any investment made in the future inTarget Company.
- Stocks andPossibilities related to Target Company
Theacquiree should check for how long period the Target Company had been tradingin the market. The term oftrading is whether short or long should also be reviewed by the acquirer. TheTarget Company, whether had any steady stock price or the stock prices werealways fluctuating, should be reviewed by the acquirer.
Conclusion
A vast majority of the modern companies are managed and operated by professional persons, and these professional persons hold a responsibility to clarify and demonstrate the shareholders the necessity and feasibility of any change in the Company. The process of Financial Due Diligence provides the platform to the professional persons of the Target Company to explain the need for change in the Company. On the other hand, the Financial Due Diligence is a process to provide a reasonable overview of the working of the Target Company to the acquirer as well. Hence, this process is a necessary and indispensable tool for the acquirer to overlook the risks and issues involved with the Target Company. So, the acquirer conducts the process of Due Diligence in the Company. The process of Financial Due Diligence is long-lasting, lengthy, and time-consuming. We at Corpbiz have experts to help you in the process of Due Diligence. Our experts will help you and assist you in the process of Due Diligence. The experts will ensure the successful and timely completion of your work.
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