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Financial Due Diligence

In a Merger and Acquisition (M & A) scenario, companies have to ensure that due diligence is carried out. The parties involved in a private acquisition process are the Buyer, Seller, and the Target Company. There are different forms of due diligence that have to be carried out by the buyer. Financial Due Diligence is one of the processes carried out in a typical due diligence exercise.

Financial diligence is a subset of the due diligence that has to be carried out by the buyer. Financial due diligence consists of the business's evaluation of assets, financial statements of the business, and the position of current assets and liabilities of the business.

Package inclusions:
  • Financial Due Diligence Consulting Services.
  • Procedure for Carrying out Financial Due Diligence Services.
  • Legal Framework for Financial Due Diligence in a Company
  • Complete Financial Due Diligence Report.
  • Monitoring Future performance related to financial protocols followed by the company.
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What is Financial Due Diligence? 

Finance due diligence is conducted to understand the financials of a target company. This is crucial for the buyer to understand the position of a target company. 

Why are Financial Due Diligence services conducted?

  • Financial Due Diligence is conducted to know the financial situation of the target company.
  • It is essential for the buyer to understand if there have been any forms of problems in the target company.
  • Carrying out financial due diligence would provide confidence in the minds of prospective investors and shareholders.
  • The buyer following protocols on financial due diligence would comply with the due diligence standards prescribed by different authorities in India.
  • It would update the buyer on the relevant compliances taken by the buyer.

Relevant Legislation for Financial Due Diligence in India

The law related to financial due diligence in India is the Companies Act 2013. Apart from this, the laws related to SEBI, Income Tax Act, Banking Act, and the RBI Act govern the regulation of financial due diligence in India. 

Procedure for Financial Due Diligence

Financial Due Diligence

Transaction Starting

At the beginning of the transaction, there is specific information collected by the due diligence provider. The due diligence provider is normally a third party in the transaction. The third party is usually a management consultant, law firm, chartered accountant, or an investment bank. Enterslice is a leader to carry out complex due diligence exercises. We have a team of expert professionals to assist your organization in carrying out Financial Due Diligence.

The following have to be carried out before beginning the due diligence exercise:

  • Secure the background information on the target company.
  • Conduct training sessions for the employees who are involved in the due diligence exercise.
  • Send out a Due Diligence Questionnaire (DDQ) to the seller or the Target company to retrieve financial information. This will involve liaising with third parties such as government agencies, chartered accountants, and external advisors.

Management of Data

In the second step of the financial due diligence process, data management is conducted. Managing data is crucial during a due diligence exercise. Management of data is known as the exchange of information between different departments. Once data is exchanged, they are stored in server rooms. Frequent data backups are required on the information stored in server rooms.

The following have to be carried for proper management of data:

  • Receiving electronic documents.
  • Storing documents in the server room (Data Room).
  • Having frequent backups on information present in the server room. 

Due Diligence Investigation and Finding

Once information is obtained through financial due diligence, this information must be cross-checked and investigated with various authorities. The authorities involved would include the Government of India, Income Tax Departments, Chartered Accountant of the Company, Ministry of Corporate Affairs (MCA), and the Securities and Exchange Board of India (SEBI).

Financial Due Diligence Investigation would include the following:

  • Analysis of the documents received- such as audited balance sheets, statements of assets, and liabilities of the companies, any form of loan taken by the company.
  • Raising Clarifications wherever required- Issues related to financial findings have to be raised with relevant authorities.
  • Apart from inquiring with other authorities, it is beneficial if the third party consultant carries out independent verification of the accounts' and the party's financial transactions.
  • Once these findings are obtained, clients must be informed if there are any forms of inconsistencies.

Review

In this phase, the due diligence provider must note the above investigations and findings of financial due diligence. All these findings have to be incorporated in the offer document of the due diligence exercise.

The following have to be carried out in the review phase:

  • Note down all the findings of the due diligence exercise.
  • Conduct a thorough analysis of the same.
  • Conduct research on the reports published on financial standards.

Transaction Ending

In the last phase of the due diligence procedure, the due diligence's findings have to be reported to the concerned parties. Apart from this, the buyer has to be informed about any inconsistencies about the target. The due diligence provider must also maintain due diligence reporting.

The following has to be carried out in the transaction ending phase:

  • Compliance Reporting- Whether the target company has maintained reports with the SEBI, MCA, Registrar of Companies, and the Income Tax Authorities.
  • Disclosure- Carrying out disclosure to prospective investors. 

Due Diligence Check List 

For Finance Due Diligence, the following checklist has to be followed:

Business Criteria

Information on the company:

  • This would include information on the projects which the business is entering into.
  • Finance strategies for the above.
  • Loans took.
  • Business Structure of the company.
  • Seed Finance Options took by the company.
  • Employees in the organization.
  • Information on the Financial Team.
  • Information on the Chartered Accountant (CA) recruited for the organization.

Incorporation Documents of the Company:

  • Memorandum of Association (MOA) and Articles of Association (AOA).
  • Other information such as crucial members of the financial team of the target company (who are involved with the financial functions) of the company.
  • Information on Intangible property of the company- preferable valuation of the same. The intellectual property will include all the company's trademarks, copyrights, and patents owned by the company.
  • Information on the following:

a) Audited and unaudited financial statements of the company.

b) Information on cost accountants appointed by the target company.

c) Information on the auditors appointed by the company.

d) Any form of reports such as the internal controls, finance, cash outflows, and inflows within the business.

e) CARO report of the target company.

f) Information on the KPI for the target company.

g) Life Cycles of Products, Categorization of Products, product cost, and manufacturing cost.

  • The internal audit report of the target company if conducted previously.
  • Quality Assessment Reports carried out on the target company if any.
  • Report on the audit committee appointed by the management.
  • Information on Accounting Procedures followed by any subsidiaries of the parent company.
  • Future contracts entered into with any other company. Any form of agreement, such as investment agreement, entered into with the company.
  • Copy of details such as the DIN number of directors, information on PAN and TAN cards of the company.

Information based on the Profit and Loss Account:

  • Information on revenues earned by the company.
  • Any form of agreement that the shareholders, partners, and directors of the company. Revenue generated from the above agreements.
  • Invoices raised on the products of the company.
  • Breakdown of the sales of the company in the previous five years.
  • Contracts entered into by the target company with the vendor or third-party supplier.
  • Information on the present bills and future bills raised by the company.
  • Information on the salaries provided to the employees.
  • Information on lease agreements the company has entered into for its premises.
  • Professional Fees charged to the target company for providing professional services.
  • Marketing, Technology, Research and Development costs and expenses associated with the company.

Information on the Balance Sheet:

  • Information on the assets and liabilities of the company.
  • Information on the fixed assets, tangible and intangible assets of the company.
  • Depreciation application to machinery, both movable as well as immovable machinery.
  • Cash and advances received by the company.
  • Information on the receivables of the company.
  • Loans/ Mortgages and Advances of the company. If the company takes loans, then information on the maturity period and interest payable on such loan of the company. Loans and borrowings must be classified as secured and unsecured borrowings.
  • Information on any form of deposits taken by the company. If the company takes term loans, then information on the loan taken and the purpose of the loan also must be mentioned.
  • Related party transactions – If entered into by the shareholders or the directors of the company. As per the companies act, 2013 information the related party transactions must be mentioned.
  • Any form of guarantees given by the company.
  • Information on the shareholding pattern with the company. Contribution to the shareholders of the company. Details of any form of Employee Stock Options (ESOPs) used by the company.
  • Details of the target company have any foreign branches or subsidiaries. If this is present, compliance must be maintained as per the provisions of the Foreign Exchange Management Act, 1999.
  • Information on Taxes such as direct taxes, indirect taxes, Goods and Services Taxes (GST) on products and services offered by the company.
  • Details of Employee Provident Funds and Statutory Provident Fund and any form of professional tax payable by the company. 

Enterslice Benefits - Financial Due Diligence

  • Enterslice is a recognized management consultant in providing due diligence services.
  • We have experience in carrying out professional due diligence services to assist your company find out any issues in the transaction.
  • Our due diligence team will conduct a detailed analysis and review after meeting key management executives of the parties in the transaction. After this, we carry out risk profiling based on the information received.
  • We have Multifaceted teams of professionals comprising Chartered Accountants, IT professionals, lawyers, and company secretaries.
  • We have extensive experience in handling matters related to mergers, taxation, and accounting matters in India. 

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Frequently Asked Questions

The terms finance and accounting can be used interchangeably. However, these terms are different when it comes to an understanding of the procedure for due diligence—financial due diligence is understanding the aspects of the company from a financial perspective. Accounting due diligence would deal with the accounting criteria of the company. Provisions related to income tax would also be dealt with under accounting due diligence.

Main objectives of conducting financial due diligence are as follows:

• To ensure that the target company has proper financials.

• To improve the trust of prospective investors.

• Look into the financials of the company.

Financial Due diligence is important for the buyer to understand what is offered by the target and the seller. Financials are the most crucial aspect that keeps a company running. Without proper analysis, the target company can be having poor financials. Hence, financial due diligence is important for the buyer.

The third-party due diligence provider would conduct due diligence. After this, a due diligence report will be given to the party. This report is something like an investigation report where the buyer will understand the variables of the business.

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