Financial due diligence is of great importance when it comes to mergers and acquisitions for both the parties involved. This allows both the companies in the process to make informed and smart decisions about the purchase. It is a procedure that is undertaken by the potential buyer of a company to assess the stability and financial health of the assets that are up for sale. The purpose of financial due diligence is to provide comfort and transparency to the party that will be acquiring the business.
During this process, the financial data is inspected and the areas that can pose potential risk are highlighted. Financial due diligence basically evaluates the true situation of liabilities, tax risks and assets, and determines if the accounts of a company are consistent or not.
Importance of Financial Due Diligence:A financial due diligence process involves a multitude of methods such as comparing the financial data, conducting interviews with key employees and senior employees, reporting the actual operational position and tax risks, documents review and trend analysis. This process is not limited to acquisitions and mergers, it is also helpful in joint ventures and other financial deals.
The goal of this due diligence process is to eliminate any asymmetry of information to allow the acquiring party to understand the depth of the situation and make a better decision. Due to differences in the characteristics of different industries, the process of financial due diligence needs to be modified as per the specification of the acquiring party.
Financial due diligence process is of great importance in realising the following functions:
To get an understanding of the real situation of operations management, internal control and assets and liabilities of the target firm. To provide a strong foundation to formulate a business plan, make investment decisions and follow up the negotiations.
Analysis of the past cash flows and profitability, on the basis of that, the future operational prospects of the firm
To provide all the potential as well as real financial and tax risks
Process of Due Diligence:The process starts with the formal expression of the buyer’s interest in acquiring the company. After this, both the parties go through initial discussions that are based on purchase terms. Once the discussions have been conducted, the investment principles can be created. This will be followed by the signing of confidentiality agreements by both the parties. Once the target company provides all the necessary and related documents, the financial due diligence process begins.
Benefits of Financial Due Diligence:The financial due diligence report is basically for the buyer that allows him/her to get an understanding of the past and real financial performance along with the future financial solvency of the firm. The result of this is informed valuation of the company. In addition to underlining the tax or financial risks, the investor also gets an understanding of the operations management structure, assets and liabilities of the target company. When this is combined with other forms of due diligence, a strategic and informed decision can be made about the acquisition.
These benefits are not only limited to acquiring company but also to the target company as they get a clear picture of their strengths and weaknesses. On the basis of this, they can do
probing from a buyer’s side. Moreover, if the target company works with the financial intermediary, it instills confidence in them that increases the value of firm.
Due diligence provides a comprehensive set of information about the target company that allows the acquiring company to understand any potential risks and uncover the opportunities.