When undertaking due diligence for a potential business acquisition opportunity, one of the most important pieces of the puzzle is the reviewing of business financial statements.
What are Financial Statements?
Financial statements are the formal records that have been prepared by the company accountant reflecting the financial activities and position of a business. The financial statements should be presented in a structured manner that is easy to understand.
It is important to understand the key things to look out for when reviewing financial statements and conducting due diligence, it is about much more than how many zeros are written at the end of the profit figure. Let’s identify and examine some of the key areas that should be carefully considered when reviewing financial statements.
Question 1: Do the Financial Statements Provide a True Reflection of the Company’s Performance?
Step one in reviewing business financial statements as a part of due diligence, is assessing if they provide a true reflection of the company’s performance. To do this, it may be necessary to conduct a thorough audit of the company’s financial statements.
Public companies and certain private companies are obligated by law to ensure that their financial statements are audited by a registered auditor. The purpose of these independent audits is to provide assurance that management has presented statements that are free from material error. This gives additional reassurance that the statements should reflect the true financial position of the company, however it is not a guarantee and means that audited financials still need to be closely scrutinized. Many private companies are not required to have their financial statements audited and when companies are looking to sell, they tend to want to ensure the financials show the best picture possible of their company which can sometimes affect the reporting quality in the financial statements. It is best to ensure that you have an experienced professional review all income and expense items to ensure all are legitimate income and expenses of the company.
Question 2: Are There Any Abnormal Expenses?
The financial statement should be reviewed and analysed not just for the current year but also the previous years, looking at trends of expenses. It is advisable that the financial statements are reviewed for a minimum of 5 years into the past to understand the long term performance of the company. When reviewing the long term performance the reviewer should look into the trends with the income and expenses. Is everything ‘normal’, are there any abnormal expenses? This may involve calculating changes in margins and financial ratios to ensure the company is not in a long term decline or has unsustainable debts or working capital requirements.
Other Questions to Ask When Reviewing Business Financial Statements
As we have alluded to above, reviewing business financial statements in preparation for potentially buying a business is much more in depth and widely scoped than simply taking the figures on the page at face value. Often it is important to understand the context and reasons behind certain transactions or events in order to gain a comprehensive perspective of the business operations and position.
Some other questions that you, or the professionals that you have engaged to assist you in the due diligence and acquisition process, might need to consider include:
- In case of a significant change in business and / or significant non-recurring events, how did this affect accounting, including judgments and estimates; recoverability of assets; segment reporting and potential classification issues?
- Were any known errors not recorded and why? How did management assess materiality and control implications?
- Have all significant subsequent events been properly reflected and / or disclosed in the financial statements?
- Are there any special purpose entities that require consolidation by the company? Have the company’s relationships been properly disclosed?
- Have there been any disagreements between management and the independent auditors on accounting principles or how to account for a significant transaction? How were they resolved? What were the issues for which the auditor consulted with its national office?
- (If any) What was the focus of comment letters / requests for information received related to the company’s filed financials from the financial markets regulator?
Analysing the financial statements and financial performance of a business is an imperative part of the business acquisition process. It is important to engage the services of experienced accountants and due diligence experts, like the team at The Quinn Group, to ensure that you are making an informed decision about how to proceed through the purchasing process.
For comprehensive and personalised service to inform your business acquisition and due diligence process, whether it is reviewing business financial statements or a complete due diligence analysis and review, contact our experienced accountants and auditors by submitting an online enquiry form, calling us on 1300 QUINNS or alternatively, +61 2 9223 9166 to arrange a teleconference or appointment.
Content updated: 20 May 2021