Financial Due Diligence (FDD)
Do you worry if the Company acquired via merger & acquisition deal is overvalued?
Why bought at overprice while you can prevent it via Financial Due Diligence?
What is Financial Due Diligence?
Financial due diligence is a comprehensive investigation and analysis of a company’s financial health, performance, and position conducted by potential investors, acquirers, lenders, or other stakeholders before making significant business decisions.
The primary objective of financial due diligence is to assess the accuracy, reliability, and completeness of financial information provided by the target company and to identify any potential risks, liabilities, or red flags that could impact the investment or transaction.
Who needs it?
Financial due diligence is typically conducted in various business scenarios, including:
- Mergers and Acquisitions (M&A)
- Private Equity and Venture Capital Investments
- Debt Financing
- Restructuring and Turnaround Situations
- Suspected fraud in the operation
Comparison Between Audit & Due Diligence
Audit
- Statutory requirement.
- Auditor issue opinion.
- Auditors direct and inform client on scope and information required.
- Governed by auditing and accounting standards.
- Recurring services.
Financial Due Diligence
- Not a statutory requirement.
- No specific opinion, it depends on the scope.
- Scope of work depends on client’s needs.
- No specific standards. It is based on professional judgement and guidance from standards.
- Upon requested/Ad-hoc
Process of FDD
Initial evaluation of the prospective company.
Comprehensive assessment and overview of the target company’s financials, which will vary based on associated costs and risks.
Determine of red flags and communicate.
Scope and focus on high risk areas.
Financial Statement
- Review of assets and liabilities
- Impairment of assets
- Potential bad debts
- Unidentified borrowings
- Working capital analysis
- Ratio analysis
- Cash flows analysis
Income Statement
- Profitability & Margins
- Projections & Forecasts
- Related Party Transactions
Others
- Tax Compliance
- Contingent Liabilities
- Capital Expenditure
- Accounting Policies
Company Background
- Business Model & Strategy
- Management & Governance
- Legal & Regulatory Requirements
Customers
- Customer Base & Concentration
- Contracts & Agreements
- Sales & Retention Metrics
Suppliers
- Supplier Base & Relationships
- Contracts & Terms & Conditions
- Supply Chain Stability
Common
FDD Issues
Statement of Financial Position
- Inaccurate Valuation of Assets: Over or under-valuation of assets like inventory, receivables, or fixed assets.
- Hidden Liabilities: Undisclosed debts, legal claims, or environmental liabilities.
- Unreported Off-Balance Sheet Items: Liabilities not recorded on the balance sheet, such as lease obligations.
- Weak Internal Controls: Insufficient internal control systems affecting the integrity of financial data.
Statement of Comprehensive Income
- Overstated Revenues: Inflated income figures, potentially misleading future performance expectations.
- Understated Expenses: Expenses not recorded or under-estimated, skewing profitability.
- Non-Recurring Income or Expenses: Misleading presentation of one-time items as regular occurrences.
- Hidden related party transaction not taken up in the account.
- Additional cost incurred due to unfair contract arrangement with related party.
Business Background
- Customer Concentration: Over-reliance on a small number of key customers, increasing business risk.
- Supplier Dependence: Heavy reliance on a few suppliers, risking supply chain disruptions.
- Legal & Regulatory Issues: Potential legal disputes or non-compliance with regulations affecting business operations.
- Management Concerns: Issues with the management team’s expertise or integrity.
Liquidity
- Cash Flow Problems: Inability to generate sufficient cash from operations, affecting liquidity.
- Working Capital Issues: Poor management of current assets and liabilities, leading to liquidity constraints.
- Debt Obligations: High levels of debt or unfavorable repayment terms impacting cash flow and financial flexibility.
Financial Projection Review
- Unrealistic Projections: Overly optimistic future revenue or profit forecasts not aligned with historical data.
- Inconsistent Assumptions: Variations in assumptions for future growth or costs across different projections.
- Sensitivity Analysis Gaps: Lack of or incomplete analysis on how changes in key variables impact projections.
How Can CCS Help You?
CCS can act as Financial Due Diligence auditors for due diligence exercised.
CCS can assist to review matters of financial nature that importants to investors in making sound decision in an investment and merger and aquisition process.
In achieving this, CCS will dive in the financial aspect of the target which includes but not limited to their financial reports, contracts and agreements, debt and financing arrangements, assets and liabilities analysis and etc. to advice on the transaction and to support the acquirer on identifying issues in the financial statements of the target.
As such, choosing the right team, scope and professional firm for your due diligence exercise is important.
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