Why Financial Due Diligence Is Crucial In The Acquisition Process?

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The meaning of due diligence is to perform a careful review. In the context of an acquisition, it includes both legal and financial aspects. Legal due diligence consists of an analysis of legal impediments and critical legal documents relevant to the business. And financial due diligence verifies the factual accuracy of commercial claims made by the seller.

It is essential to know that a due diligence review is neither an audit nor a valuation of the target company. Although they share some standard procedures and purposes, they are different. The difference lies in the fact that due diligence is a detailed investigation majorly focused on the information given to the buyer, mostly via financial statements.

A financial review allows you to assess the financial aspects of an acquisition (like benefits, risks, liabilities, and opportunities) as a buyer. The best way to ensure that your payment is justified is to club other forms of due diligence with financial due diligence. Financial due diligence is one of the review engagements that interested investors are likelier to request to perform a financial review of the target company.

Financial due diligence is mostly concerned with the identification and review of the targeted company’s financial position and potential liabilities (like continence liabilities), which is not stated in financial statements and records of the company.

In some cases, investors purchasing the company are not expecting profit from the current performance, but from the future growth of the business. Here the investors do not want to see the current position of the company in the market. They are interested in checking their potential for the future, and here financial due diligence comes handy.

Why is financial due diligence so crucial in the acquisition process?

Financial due diligence is crucial for the investors for the acquisition of the targeted company since it doesn’t only help them to understand the past and current financial situation of the target company but also helps them predict the future financial position of the company. Apart from uncovering the potential financial liabilities, it also helps the investors gain more perspective about the business of the targeted company, which is very important for them to make the correct decision.

Sometimes, the investors come to know that shareholders of the company or corporation do not trust the management, or the shareholders themselves do not hold any trust among themselves. In such a case, shareholder needs typically to present professional accounting or financial due diligence of the financial statements. Then they will use report results from those services as part of the evidence in solving the argument among the shareholders.

In short, the purpose of financial due diligence is to help the investors assess and understand the financial position, know unrecorded liabilities, predict future cash flow, and help investors for making better decisions.

There are several factors involved in the acquisition process that need you to make a quick decision. Due to these factors, you need to choose one of the following options for the deal:

  1. Go back to the negotiation table

  2. Walk away completely

  3. Continue with the purchase

The factors are:

  1. The variance in the quality of financial information

  2. The significant value involved in purchasing a business

  3. The information provided during the negotiation phase

What should you look for?

This is a common question where the acquirer is unaware of the business sector. The simplest solution is to try for an in-depth agreement. The more comprehensive and thorough it is, the better. This agreement should enable you within the allocated period.

You can use a broad-brush approach, but remember, a business is not just one thing; it is a sophisticated collection of several moving parts that come together to provide outputs to your customers and returns for its stakeholders. There are many elements to consider when you look at a single business. Some of them are as follows:

  • Key deal considerations

  • Company history and background

  • The financial performance

  • Employee strengths, weaknesses & commitments

  • Tax due diligence

  • Cash flow assessment – now and forward

  • The power of financial position

  • Close off / cut off review

The below-mentioned factors are generally overlooked. But it is advisable to consider them as well:

  • Lease assessment review

  • IT environment review

  • Related party transaction review

  • Acquisition accounting

  • Foreign currency exposure review

Due diligence allows you to take a look at all the aspects of the business before the acquisition. It provides you with the benefit of speeding up your decision-making process by assessing the accuracy of information presented in the acquisition process.

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