Due diligence is an integral part of the investment process. It can be explained as an investigative practise that is carried out to validate the authenticity of the information provided. Due diligence activities can be carried out in a lot of scenarios. However, it is primarily used during M&A deals and significant investments. In these scenarios, conducting financial due diligence is of paramount importance. It helps to examine the financial documents of another entity before entering into a deal. Read on to learn more about the importance of due diligence and the role played by due diligence consultants.
Why is due diligence essential?
Due diligence is essential because it sheds light on many things that might not be evident at first glance. It takes a comprehensive approach to find anomalies in the records presented. Essentially, due diligence activities help reduce the risk for investors and other stakeholders in a business. Identifying discrepancies in financial records can be a warning against investing in a shortlisted prospect. The return on investment can be improved by doing thorough due diligence. It can help compare risks in different investments and choose the best one per the risk appetite and returns.
What does financial due diligence entail?
Financial due diligence is done to assess the economic well-being of a company. It takes a deep dive into the critical financial records, future trends and past performances. The actual scope and findings of financial due diligence can vary contingent on the industry, scale and size of business, etc. Here are some key objectives of conducting financial due diligence.
- A thorough analysis of revenue generation, cashflows, profitability, quality of earnings, etc.
- The financial due diligence process is also used to evaluate the revenue’s sustainability by assessing taxes, depreciation, working capital, assets & liabilities, projected financials, etc.
- Assessment of other vital variables that might directly or indirectly impact the performance of a business is also necessary.
Tips for conducting due diligence effectively
Due diligence requires professional guidance on various matters. Here are some essential tips to be mindful of if you expect a genuine return from the due diligence investment.
- Create a due diligence checklist
The due diligence process should start by creating a checklist of activities to be done. This will help avoid duplication of efforts, and the due diligence team will be able to tick off different items from the list as and when completed. In addition, it improves overall accountability while conducting due diligence.
- Review the corporate structure and business practices
Reviewing the company’s business structure and practices should be an integral part of the due diligence process. The documents that must be evaluated include the article of incorporation, names of shareholders, bylaws, list of states/countries where the business operates, license, permits, etc. Any corporate records for partnership agreements, vendors and supplier relationships should also be checked.
- Understand corporate financials
To evaluate the financial health of a business, it is essential to check the annual reports, P&L statement, general ledger, accounts payable statement and accounts receivable. In addition, the due diligence team should also check the company’s collection procedure and credit policy. Finally, trends and patterns related to different financial metrics and variables should also be identified.
- Review assets & liabilities
Another crucial thing to make a part of your due diligence practices is reviewing assets and liabilities. Find out about any intellectual property that the businesses possess and check if it’s a part of the deal. In addition to identifying the ownership status of different assets, their economic value should also be assessed. The due diligence team is responsible for examining trade secret policies and procedures. Finally, it is critical to perform a complete assessment of the physical assets, including real estate property, inventories & raw materials, office supplies, manufacturing tools & equipment, etc.
- Hire a due diligence consultant
Hiring a due diligence consultant is the most intelligent way to examine the authenticity of records in a business deal. Due diligence consultants have expertise in conducting different assessments, and they know what to check for in a business deal. The right due diligence consultant can save you a lot of time and resources. Hiring reputed and experienced consultants is essential to make the most of the due diligence investment.