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Financial Due Diligence

Financial Due Diligence 

It is an essential process in any M&A that involves review and evaluation of any investment opportunity, disposal or reorganization.

It is a process important in M&A by which confidential legal, financial, tax, management, HR, operational and commercial information are reviewed and exchanged between key stakeholders and senior management.

 1.    Understanding the Business

A detailed understanding and description of the following areas:

  • Business and revenue model.
  • The business strategy, high-level industry overview, and competitive landscape based on secondary/desktop research.

Analysis of revenue and margins, payroll costs

Detailed review and understanding of Key Contracts and Agreements

2.    Quality of Earnings

  • A quality of earnings report assesses how a company accumulates its revenues – such as cash or non-cash, recurring or nonrecurring.
  • Typically, it involves an examination of revenues, gross profit, and EBITDA, ultimately leading to the calculation of an adjusted EBITDA.
  • This analysis strives to represent earnings as a key factor in determining a company's value by accounting for exceptional, non-recurring, non-operational, pro forma, and other factors in the reported results.
  • Identify any red flags such as concentration risk, sales trends, seasonality factors. 

3.    Net Debt and Cash Flows

  • Net debt and cash flow adjustments serve to accurately assess a company's financial health and value.
  • They help determine the actual debt exposure by considering debt and debt like items, enabling a more precise valuation.
  • Additionally, adjustments to cash flows highlight the sustainability of a company's operations and potential financial risks.
  • These adjustments are crucial for ensuring that financial information reflects the true financial position and capabilities of the target company, supporting informed investment and acquisition decisions.

4.    Working Capital

  • Working capital is examined as a measure to gauge a business's ability to generate or use operating cash.
  • During due diligence, the focus is on determining the typical level of working capital.
  • By analyzing working capital trends within the month, cash flow patterns and peak requirements, this process aids the buyer in negotiating the "Target Working Capital" for the transaction and in evaluating whether additional financing arrangements are required with lenders.

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