By Bojan Radojicic
FINANCIAL
DUE
DILIGENCE
4 MUST HAVE
ANALYSIS
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1 Quality of Earnings
Identify normal and sustainable level of operational
earning
This help to make sure that multiple-based price we
pay for transaction is fair
Usual subjects of adjustments : Revenues, Costs, Net
Working capital
Sources of data for review: Management and public
reports, auditor reports, disclosures, post-year
events, seasonality analysis,
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1 Quality of Earnings
Some of key procedures to idenfity anomalies
Analyze of periodical changes in costs and revenues
(monthly, annually)
Analyze variances: actual vs. budgets
Compare official accounts with management reports
and business plan
Review of key ratio numbers and changes in ratio
numbers
Review monthly movement in sold quantities,
purchased units etc.
Test of accrued expenses and cut offs.
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1 Quality of Earnings
Examples of earning adjustments done in QoE:
Excluding one – off revenue and costs (non –
recurring and discontinued operations)
Adjusting transactions with related parties to market
level (arm’s length principle)
Excluding start – up costs (costs made for
expansion)
Including annualized income for new business units
(from previous bullet point)
Reviewing end – of – year provisions and accruals
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2 Net Working Capital
My favourite checks:
Movement in NWC and its main components,
review of DSO, DIO and DPO.
Fair value of receivables: overdue, bad debt,
payment terms, litigation, balance structure, after
balance sheet date collection
Compare NWC/Revenue ration with industry
benchmark and peers.
Quality of inventories: potential obsolescence,
historical write offs, general conditions, DIO
movement
Check trade payable overdue if any (this is sign to
increase NWC, compare payment terms with
industry benchmark)
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3 Proof of Cash
Importance of PofC
Detection of fraudulent activities
One of the primary reasons for performing a proof
of cash is to identify any discrepancies or unusual
transactions that might indicate fraud.
Evaluation of internal controls
A proof of cash can also shed light on the
effectiveness of a company's internal controls
related to cash transactions. If there are numerous
reconciling items or discrepancies, it might indicate
weak internal controls.
Assessment of cash flow
For a potential buyer or investor, understanding the
cash flow is crucial. The proof of cash provides a
detailed view of cash receipts and disbursements,
helping assess the company's liquidity and
operational efficiency.
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3 Proof of Cash
How to conduct
Make PofC Model
Gather necessary documents: Obtain bank
statements and the company's cash ledger for the
period under review.
Break down the period: Divide the period into
smaller segments, such as monthly, to make the
analysis more manageable.
Verification of cash transactions: It ensures that all
transactions affecting cash are recorded correctly in
the company's books.
Match company data outputs with your model:
Check if your test given in form of model shows the
same results as real cash in company and analyze
differences.
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4 Net financial position
Importance of NFP
Measure of NFP is importance for valuation, as
NFP is to be deducted from enterprise value to get
equity value.
Acquirers often leverage debt to finance
acquisitions. A clear understanding of the target's
NFP is crucial to determine how much additional
debt both companies can bear
A healthy NFP might indicate that the target
company has been generating enough cash and
has the capacity to invest in future growth
opportunities
High liabilities or a negative NFP can signify
potential liquidity problems, impacting the overall
risk profile of the acquisition
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