What Practising Financial Due Diligence Actually Means… And How To Achieve It

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When important financial transitions take place, such as takeovers and mergers, they must be supported by robust checks. Financial due diligence is the thorough examination of the financial performance of a company before a major transaction happens.

What Does It Mean To Practice Financial Due Diligence?

Financial due diligence is commissioned by businesses who are interested in partnering or taking over another business. Before the transaction is finalized, a series of financial checks are made.

Through financial due diligence, the commissioning company aims to:

confirm financial information received from the target company is correct;
uncover red flags that would mean aborting the transaction would be necessary;
identify risks associated with the transaction that would need to be covered by contingency planning;
gain a full understanding of the target company;
assess potential profitability;
identify strengths as well as weaknesses within the target company;
acquire information of use during negotiations.

How Does Financial Due Diligence Work in Practice?

Financial due diligence is a detailed process that must be completed by experienced financial consultants. Transaction advisory services providers are the experts that can perform this specialist task.

It is always recommended that the process be completed by expert professionals who are both independent and experienced in the intricacies of the task. This ensures there is no risk of bias and that maximum benefits are gained from the financial due diligence process.

For the acquiring company, the advantages of using a transaction advisory service to complete financial due diligence include:

ease;
an independent perspective;
an ability to make fact-based decisions;
a stronger position during negotiations;
a confident outlook that results from a clear perspective;
more time and resources to focus on planning the transaction;
lower risks during and post-transaction.

Permission to complete financial due diligence must be sought from the target company.

The target company is required to be transparent and open, and produce all documentation required by the transaction advisory service. To protect both sides, a confidentiality agreement is usually produced.

What Do Transaction Advisory Services Do During Financial Due Diligence?

Financial due diligence is a complex process. During the period of analysis, transaction advisory service providers will:

carefully analyze and assess the target company’s financial statements and records to ascertain how accurate they are;
identify undisclosed risks;
analyze future earning capabilities;
gather a range of information and expertise from experts within the industry;
produce a detailed report of their findings.

To complete a financial due diligence report, the consultants will focus on three main pillars of the target company’s finances. They are:

Sales
Costs
Operations

The exact process will vary depending on the structure of the company, the industry, and other variables. A good consultancy will adapt and tailor the process to suit the acquiring and target companies. Input from other independent industry experts will also help guide the individualization of the process.

Although variation should be expected, here is an overview of how the consultants will typically tackle the three pillars of sales, costs and operations.

Sales

To identify income, the transaction advisory service will analyze current sales. It will also examine the company’s historical data to identify seasonal patterns, periods of stronger or weaker sales, and anomalies.

To perform this analysis, the consultants will take a deep dive into sales invoices, receipts, bank statements, accounts, and any other relevant documentation.

Any sales projections made by the target company will be carefully examined. The consultants will provide an independent view of whether these projections are conservative or overstated.

Costs

Business costs can be fixed, recurring payments, or they can be variable. To gain a full understanding of the target company’s outgoings, both regular and occasional, a detailed analysis of various documentation is required.

Transaction advisory services will scrutinize utility bills, purchase invoices, receipts, bank statements, rental agreements, and other documents over recent years to fully detail outgoings. Expert professionals can determine how honest and realistic any presentations of costs made by the target company are.

Operations

Checking financial operations is vital. The transaction advisory service can determine whether the target business is operating its finances correctly, if it owns all appropriate licenses, and whether all its operations take place within the law.

In many countries, laws exist to prevent corruption, bribery and money laundering. In addition, there are international laws that apply to companies that are active outside of their country’s borders.

Why Is Financial Due Diligence Essential?

The reasons for undertaking due diligence are manifold. All are protective of both the commissioning and target companies by ensuring that any transaction is in both parties’ best interests.

The essential takeaways from due diligence include:

Lowering risks

No major transaction is without risk. However, the thorough examination of a company’s finances through due diligence is the best way to ensure that all risks have been considered and appropriately evaluated.

Financial due diligence involves a systematic approach that leaves no stone unturned, so that purchasing companies can be confident that all potential risks have been discussed before making an investment decision.

Taking the appropriate and legal steps to ensure laws and regulations are followed

The use of a knowledgeable and independent transaction advisory service helps protect the commissioning company from being associated with or embroiled in any illegal activity. Working with business partners who break financial laws puts your personnel and yourself at risk of penalties and even custodial sentences.

Ensuring laws and regulations are being followed also helps preserve the good reputation of the commissioning company and also consolidates the reputation of the target company as well. The commissioning business can be sure of the ethical and legal standards of the company they are to acquire or partner with.

Ensuring future profitability

Any major transaction needs to be fruitful in the long term. Transaction advisory services can make reliable projections of future profitability based on all the available evidence at their disposal. This independent prediction means that both companies involved in the transaction can be confident of its success.

How to Find Out More

Business consultants in the UAE can offer advice to businesses considering mergers and acquisitions. As well as transaction advisory services specializing in financial due diligence, they can aid valuations, the preparation of pitch decks, both buy-side and sell-side businesses, and raising capital.

Consider approaching these experts for personalized advice on financial due diligence.