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Understanding the Whole Picture


Buying a business is a significant investment with numerous inherent risks. To manage those risks, buyers or their advisors must conduct due diligence after an offer has been accepted, but before the deal closes. Yet many buyers believe that due diligence only involves analyzing the business’s accounting information to find out whether the numbers are correct when in fact, due diligence can provide a wealth of information that can have significant benefits for a buyer.

Having a professional conduct financial due diligence (as opposed to accounting due diligence) gives you a much more complete picture of the risks and benefits of the acquisition. Below are three areas of financial diligence that provide valuable information.

An overall look at how the business operates

Even if you understand the business you want to acquire—its product, market and industry—you need to know what is actually happening in the company itself in order to effectively manage your risk. Are there issues with suppliers or customers? Are key employees secured through employment contracts? Do any reputational risks exist? Will accounting and information management systems be compatible with those in your current business or will you need to make an additional investment in technology?

The answers to such questions cannot be found by looking at the business from a strictly accounting perspective. Finding the answers requires discussion with the current management team on how the target company acquires customers, how sales are made, how revenues are recognized, what kind of capitalization policy is used and how inventory valuation is handled. With this information, financial analysis can be performed with an understanding of where the risks lie to give you a much wider perspective of the potential issues.

Dive deep into the gross margin

Financial results and forecasts prepared by the seller can be analyzed in a way that also provides more information. A careful look at the numbers allows your financial advisors to tell you what does and does not make sense. Any variances in the numbers from what should be expected compared to either historical data or industry benchmarks can be noted and investigated.

This type of analysis has two potential benefits for buyers. The first is that areas of concern can be ‘red flagged’ so the buyer can look into them and possibly make a downward adjustment to the price offered in the letter of intent. Secondly, synergies or additional value the buyer has not foreseen can emerge. Knowing that you are getting a better deal than you thought is powerful information when you head into negotiations.

Review significant contracts

Lawyers review contracts from a legal perspective, but there is value in having them reviewed from a financial perspective as well. This can flag any direct exposure you might face as a result of specific contracts, but also potential benefits, for example, keeping leases and subleasing them to crystallize the value on certain contracts.

By examining these areas in the due diligence process, your advisor can give you much more value than a simple accounting analysis will provide. Financial due diligence is also a good idea if you are buying a division of a company, as it can be very difficult to assess the value of a division when it would not normally be segregated in the seller’s accounting system as an independent entity.

In any transaction, having your accountant act as a financial advisor by conducting a thorough financial due diligence is the best way to enhance your investment and make sure you know the true value of the deal you are making.