Financial Due Diligence

What is Financial Due Diligence?

Financial Due Diligence in M&A is the process undertaken typically by an Accountant to investigate, review and consider the reasonableness of the financial performance and financial position of a target entity. The goal is to identify and assess risks or "red flags" which are crucial in the decision making of an acquirer in a transaction. Uncovering these risks during the financial due diligence stage can save the acquirer significant time and money.

Financial due diligence typically focuses on the historical financial performance and financial position of the target entity, however can also focus on forecasted financial performance. Financial due diligence is different to an Audit in that there is no opinion or assurance, rather, summarising the facts and presenting key trends and rationalises the performance of the target entity over a time period (typically three financial years).

The degree of review and analysis in a financial due diligence engagement depends on the scope which is based on the size of the target entity and the key focus areas of the stakeholders. Some of the key scope items covered off in a financial due diligence engagement include, but are not limited to:

• Historical Financial Performance: revenue, gross margin, EBITDA and EBIT.

• Quality of Earnings (QoE): reported financial performance including adjustments for non recurring or abnormal items uncovered during the financial due diligence.

• Financial Position: assets, liabilities and equity.

• Working Capital and Net Debt: identify trends and abnormalities in the typical operations of the target entity as well as any financial debt and off balance sheet exposure to the acquirer which are negotiated during the financial due diligence process and meticulously drafted into the contract of sale.

• Recurring and non recurring revenue: identify sticky customers and churned customers and the trends over the historical period.

Why is Financial Due Diligence important?

You wouldn't buy a property or a piece of plant and equipment without undertaking some form of due diligence. Acquiring a business or the shares in a company is no different. Financial due diligence empowers the acquirer in a number of ways:

• Risk identification: financial due diligence delves deeper into the finance function of a target entity beyond the face of the financial reports. An acquirer who is informed of any risks early is better equipped to make the decision to proceed with the transaction and steer negotiations with he vendor.

• Supporting the valuation: a clear understanding on normalised earnings (QoE), working capital and net debt are fundamental to the Enterprise Value to Equity Value bridge.

• Acquirer confidence: being informed on risks and having a independent representation of the factual findings of the financial due diligence gives the acquirer and other stakeholders to transact with confidence.

Financial Due Diligence with PCM Advisory

PCM Advisory have the knowledge and experience in SME transactions to assist you in your transaction needs. With the skills of a mid market firm and the look and feel of a boutique firm your transactions costs will be managed without a lapse in quality.

Contact us today to book a meeting and see how we can help. Home