Risk, Assurance and Due Diligence
Due diligence is an investigation, audit, or review performed to confirm facts or details of a matter under consideration. In the financial world, due diligence requires an examination of financial records before entering into a proposed transaction with another party.
Analysing numerous factors to determine an entity’s commercial potential is known as due diligence. Evaluating the entity’s overall financial sustainability in terms of its assets and liabilities examining the entity’s operations and confirming the relevant facts in relation to a proposed transaction. The term “due diligence” refers to a thorough assessment of a company’s financial management system. It comprises a thorough examination of the organization’s internal control system, financial reports, and document flow. The evaluation also contains management reporting data, which deals with handling data on the company’s assets and liabilities, expense structure, and earnings from main operations, among other things.
Transaction Covered Under Due Diligence
Mergers and acquisitions: Due diligence is performed from both the buyer’s and the seller’s perspectives. The seller focuses on the buyer’s past, the financial capacity to consummate the purchase, and the capacity to uphold obligations made, whereas the buyer investigates the financials, lawsuits, patents, and a wide range of other important information.
Partnership: Strategic partnerships, business coalitions, and other types of collaborations are subject to due diligence.
Collaborations and joint ventures: The reputation of the combined company is an issue when two businesses join forces. It is crucial to comprehend the other company’s position and assess whether its resources are adequate.
Common Offer: Decisions about public issues, disclosures in a prospectus, post-issue compliance, and similar problems are involved during the making of a public offer. Normally, these would demand careful consideration.
Need For Due Diligence Report
The saying “discovering skeletons in the closet before the deal is preferable than discovering them later” is appropriate when it comes to due diligence. The information obtained throughout this process must be made public because it is crucial for decision-making. The due diligence report describes the company’s revenue-growth strategy (monetary as well as non-monetary). It serves as a convenient reference for quickly understanding the circumstances at the time of buying, selling, etc. The ultimate objective is to gain a comprehensive understanding of how the company will operate in the future. The due diligence report details how the company plans to boost revenues (monetary as well as non-monetary).
It acts as a quick reference for realizing the situation at the moment of buying, selling, etc. Getting a clear image of how the business will function in the future is the ultimate goal.
- Financial due diligence can help resolve issues that might arise later on during the purchase in advance.
- When both sides are aware of one another’s financial situations, an informed decision or negotiation can be made.
- The use of deliverables can be flexible thanks to financial due diligence.
- A third party’s objective opinion promotes more confidence between the parties.
- It is possible to predict the entity’s prospective future position, which will be a key deal-maker or deal-breaker for both entities.
Preparing the Due Diligence Report
The three W’s must be taken into consideration when writing the due diligence report. Which are:
- To whom are you trying to reach?
- What do you hope to achieve?
- What factors will be crucial in making decisions
To keep the report concise, unnecessary details should be omitted.
Concentration Areas for a Due Diligence Report
Feasibility: A detailed examination of the target company’s business and financial plans can be used to determine the viability of the endeavor.
Financial Aspect: Important financial information and ratio analysis are required to fully comprehend the situation.
Environment: No company runs in a vacuum. Consequently, it is essential to consider the macro environment and how it will affect the target organization.
Personnel: The competence and reputation of the individuals running the organization are crucial considerations.
Existing and Future Liabilities: It is important to consider any ongoing legal proceedings and regulatory concerns.
Technology: The evaluation of the technology available to the organization is a crucial issue to take into account. A required evaluation is one that helps determine future courses of action.
Effect of synergy: The ability to create synergy between the target company and the current company is a decision-making tool.
Due Diligence Methods
Business Due Diligence: Business due diligence entails investigating the parties to the transaction, the business’s potential, and the investment’s quality.
Legal Due Diligence: This process primarily focuses on a transaction’s legal elements, potential legal problems, and other legal-related issues. It encompasses both intra-corporate transactions and transactions between corporations. This diligence includes the currently existing documentation as well as several regulatory checklists.
Financial Due Diligence: This involves validating the financial, operational, and commercial presumptions. The acquiring corporation can now breathe a sigh of relief after learning this. Here, a thorough review of accounting principles, audit procedures, tax compliance, and internal controls is conducted.
Business due diligence entails investigating the parties to the transaction, the business’s potential, and the investment’s quality.
This process primarily focuses on a transaction’s legal elements, potential legal problems, and other legal-related issues. It encompasses both intra-corporate transactions and transactions between corporations. This diligence includes the currently existing documentation as well as several regulatory checklists.
This involves validating the financial, operational, and commercial presumptions. The acquiring corporation can now breathe a sigh of relief after learning this. Here, a thorough review of accounting principles, audit procedures, tax compliance, and internal controls is conducted.
Significance of Due Diligence under GST
In legal parlance, due diligence is referred to as reasonable steps taken by a person to avoid committing a tort or offence. Keeping similar perspective, increasing stringency since initial days of GST regime demands taxpayers now be all diligent in complying GST provisions. Complying all the legal provisions of GST with due diligence only would prevent from interest and penal consequences. A thorough examination of the organization’s internal control system, financial reports, and document flow helps bringing in proper internal checks and complying the provisions of GST mechanism. This is necessary for:
- Meeting return filing timelines
- Keeping reconciliations robust and self-explanatory to the maximum
- Fulfilling all the Compliance, like credit provisions, export procedures, etc.
Customer Due Diligence under PMLA (Prevention of Money Laundering Act): Customer due diligence (CDD) is of utmost significance with respect to Anti-Money Laundering (AML) and Know Your Customer (KYC) initiatives. CDD is the act of performing background checks and other screening on the customer. It is to ensure that customers are properly risk-assessed before being onboarded. Banks apply CDD to approve loan amounts for businesses, and individuals. The process is usually conducted to determine aspects ranging from their loan repayment ability, and creditworthiness, to fraud detection and involvement in unfair activities such as money laundering. Banks rely on providers of top due diligence services for CDD.
Due Diligence in Mergers and Acquisitions Transactions: General perspective that the Buyer needs to make an informed decision on the Seller is not applicable in Mergers and Acquisitions Transactions. Due diligence has value for both parties in a (y) M&A scenario. Like the Buyer and seller also determine if entering into the scheme would be beneficial financially and from a reputation perspective. And the Buyer like in general transactions needs to be aware of the risks involved to reduce them to the level of appetite, and achieve accuracy in the valuation of the target company, which helps determine in closure or avoidance of the deal and also in negotiating better. Depending on the depth of the situation almost all types of due diligence such as Financial Due Diligence, Tax Due Diligence, and Legal Due Diligence form part of Acquisition Due Diligence.