When undertaking due diligence for a potential acquisition opportunity, one of the most important pieces of information that are looked at and analysed are the financial statements of the business. Financial statements are a formal record 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, but for the untrained eye there can be many areas where potential risks may arise. Below we describe some examples of areas that should be carefully analysed when reviewing financial statements as part of undertaking due diligence.
Do the Financial Statements Provide a True Reflection of the Company’s Performance?
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.
Are There Any Abnormal Expenses?
The financial statement should be reviewed and analysed not just for the current year but also the previous years. 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. 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.
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Analysing the financial statements and financial performance of a business is an imperative part of the business acquisition process. It’s an area we’re very familiar with, hence if you require any assistance for an acquisition that you are undertaking feel free to contact us for a free confidential consultation with one of our team.