The main purpose of a Financial Due Diligence audit is to provide assurance that the financial statements present a true and fair view of a company’s financial position and performance. Audited financial statements therefore provide a good starting point for a potential investor’s evaluation of a company.
They, however, do not provide sufficient detail of a company’s business processes and operations necessary to assess the risks related to an investment. Hence the need for a financial due diligence.
Key areas of focus of a Financial Due Diligence
A comprehensive due diligence will delve into various aspects of the company or business. The key areas of focus are;
Background and economic review
This captures the company’s history, ownership, organisational structure and the key assets that drive its value. It also involves an evaluation of economic environment and outlook of the countries, geographical regions and particular sectors that the company operates in.
Accounting and financial review
This looks into whether the figures captured on the trial balances, statement of comprehensive income, statement of financial position, cash flow statement, bank reconciliations, historical and current operating results, business plans, budgets and forecasted financial information are accurate. This helps to establish the reliability of financial information provided, understand the target’s current financial position and identify unreported liabilities; if any.
Tax and regulatory compliance
The area of tax is one of the highly emphasized areas of due diligence. This involves conducting a tax health check on the company to assess the level of compliance and identify existing and potential tax liabilities. Potential liabilities could arise from non-filing that occurred in the past, under-reported tax liabilities, tax computation errors and misinterpretation of tax obligations. It also involves assessing other statutory and regulatory compliance besides tax.
This is an examination of the company’s operating systems, processes and procedures with the aim of assessing their effectiveness and efficiency in managing the business and safeguarding the company’s assets. This also helps to identify operational risks arising from the way the business is conducted. Areas that are assessed here include supply chain, production, sales, accounting and finance; amongst others.
The aim here is to understand the qualifications and experience of key personnel including any critical skills that they possess vis a vis the demands of their roles. The other aspects looked into are the remuneration structure, scope for rationalisation of staffing levels, employment contracts and accrued benefits and compliance with labour laws and regulations.
Potential or existing litigation is one area with high risk of unreported liabilities. Though legal due diligence is conducted separately, enquiry into legal fees paid and outstanding could shed light onto any cases that the company is party to.
When done properly, a financial due diligence provides valuable information that will help support an investment decision by identifying from the onset the nature and extent of any material risks associated with a target business and provide a platform on issues that need to be addressed or negotiated upon.
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