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Insert Name of Company Financial Due Diligence Report Template - Sample

(Company name)

Financial Due Diligence Report - Sample

TABLE OF CONTENTS 1. BACKGROUND AND INTRODUCTION 1.1. Industry overview 1.2. Overview of the Company 1.3. Operations Summary 2. FRAMEWORK 2.1. Environment 2.2. Owners/Alliances 2.3. Value 2.4. Customers 2.5. Management 2.6. Competitors 2.7. Information 2.8. Business Processes 2.9. Suppliers 3. THE PROPOSED TRANSACTION 4. KEY FINDINGS 4.1. Deal Issues 4.2. Valuation Issues

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4.3. Representation Issues 4.4. Post closing Issues 5. ANALYSIS OF PROFIT &LOSS ACCOUNT 5.1. Revenue 5.2. Summary of Contract 5.3 Costs 6. ANALYSIS OF BALANCE SHEET 7. ANALYSIS OF CASH FLOWS 8. LIMITED REVIEW OF PROJECTIONS 9. HUMAN RESOURCES 10. OTHER MATTERS 11. SCOPE LIMITATIONS 12. ANNEXURES

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(Company name)

Financial Due Diligence Report - Sample

1

BACKGROUND AND INTRODUCTION

vi. Kind of operations, products/services offered and the market share of each. vii. Also cover the various opportunities/threats that the industry is facing and the outlook about the industry and the company.

1.1. Industry Overview The objective of this section is to provide a synopsis of the industry within which the Company is operating. The synopsis should cover the following: i. ii. Brief industry history, growth story, market size, etc. Company‘s percentage share in the total market. 1.3

Operations Summary Provide a summary of the business areas and segments in which the Target Company operates in this section. It should cover the following: i. Service Company – Verticals in which the company operates, or; Manufacturing Company – Different products which the company manufactures/markets. ii. Table giving the break-up of latest revenue figures into different product lines/service verticals.

iii. Key industry-level risks (for example, competition, high attrition, government regulation, dependence on a few customers /suppliers, etc.). iv. Outlook for the industry and how the same will impact the target company. v. General economic conditions and trends adversely affecting the client's suppliers and customers.

iii. Broad overview of the value chain (suppliers to customers). 1.2. Overview of the Company This section aims to provide a background about the target Company and its group by providing: i. ii. Yearly achievements. Holding structure. [This space has been intentionally left blank]

iii. Name of subsidiary/locations of operations – diagrammatic representation. iv. Organizational structure. v. Number of employees in branches/locations/department, etc.

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Financial Due Diligence Report - Sample

2. FRAMEWORK The Framework is a unique manner of depicting the various internal and external factors/forces that affect the working of the Company. The objective of this section is to bring out the key characteristics of these factors and enable the reader to gain an overall understanding of the environment in which the Company is operating. The framework should cover one slide. An attempt should be made to capture those characteristics which have a direct and immediate impact on the working of the Company. Note: Framework will overlap with the previous section of ―Background and Introduction‖ (BI). However, BI attempts to provide a brief of the industry while Framework provides a synopsis of how the enumerated factors interact. BI gives an understanding about the industry in which the Company is operating and its growth path till date, (since its inception) and is more macro in analysis as compared to Framework. ii. Owners/Alliances Map the ownership structure of the Company/organization while including the: a. Inactive owners. b. Sleeping partners. c. Strategic investors.

d. Brief on the major alliances. e. Shareholding structure. f. Brief about the significant changes in ownership.

g. The direct and indirect ownership should also be reflected. For example, if A owns B and B owns C, then A owns C. h. Any special licenses, permissions, approvals required to operate in the particular industry.

i.

Environment Environment will cover all the external forces having a direct and indirect impact on the Company. The typical questions that need to be asked are: a. Growth of the respective industry and the key drivers of the same. b. How much is the industry regulated, organized/unorganized? c. What are the major concerns of the industry?

iii. Value ?Value‘ refers to the: a. The value added by the Company to the end product. b. The extent of ?uniqueness‘ of the company‘s products and the reason why the customer chooses the company‘s products over the competitor‘s products.

d. Entry and exit barriers. e. Major changes in Government‘s outlook towards this industry. For example, government concerns about ownership, monopolization etc. f. What is the market size of the industry?

iv. Customers The customer analysis should allow the reader to understand the surety of future sales revenue and estimate the extent to which the overall profitability is dependent on certain key customers. a. Major customers of the Company.

g. Structure of the industry.

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Financial Due Diligence Report - Sample

b. Comment on how specific the customer contracts are and whether these contracts allow the customer to dictate terms. For example, customers may have an option to terminate the contract without notice. c. The extent to which the company can govern the product/service prices.

b. Review the appropriateness of the management skills and any skill gaps (any specific skills that the operations of the company require and are missing in the key management team). c. Appropriateness of the reporting structure of the management.

d. Mention the percentage of sales being contributed by the top five customers. e. The switching costs involved if a customer decided to purchase from a competitor. Any costs that the Company might incur—like loss on account of software license purchased specific to an outgoing customer etc.—also need to be reviewed. f. Pricing strategies and critical factors affecting the sales prices including industry trends and product life cycles.

d. Long- and short-term perspective of management for the company – vision, mission, etc.

vi.

Competitors The review of competitors gives an important insight into the operations of the Company as it highlights why some customers have opted for the competitor‘s products and not of the Company as well as reflects upon the possibility of existing customers of the Company, moving to its competitors. a. Identify the major players and their respective market share along with the market share of the company. b. The difference in the market share between the company and i. The nearest competitor having a higher market share and the competitor‘s growth rate in revenue. ii. The nearest competitor having a lower market share and the competitor‘s growth rate in revenue. c. Identify any specific areas where the company has significant strengths and/or weaknesses as compared to its competitors.

g. Comment on the level of dependency of the company on its customers. h. The market segment, respective products/services and the price segmentation for each. i. j. k. Key marketing strategies. Distribution channels being used and the breakup of the distribution costs in terms of transportation, storage, etc. Bottlenecks in distribution. For example, dependence on very few wholesalers, transporters, etc.

v.

Management Give a synopsis about the management team leading the company and cover the following: a. Brief about the management, their background, key skill areas and time spend with the organization. vii.

Information Review the following: a. Information management mechanism/platform.

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Financial Due Diligence Report - Sample

b. Year of installation and the frequency of up gradation. c. Data backup and disaster recovery plan.

d. Flexibility and appropriateness of the system to the operations of the company.

viii.

Business Processes Give a diagrammatic representation of the processes in place for HR, invoicing, etc., and: a. Comment on the efficiency of the organizational processes by reviewing the extent to which these processes adhere to the segregation of duties (for example, independence of recording, processing and reviewing). b. Identify the various avenues of the management to track information and the processes. [This space has been intentionally left blank]

ix.

Suppliers Reflect on the dependence of the company on key suppliers by: a. Giving the percentage of the total vendor cost being contributed by the top five vendors. b. The extent to which the terms of the vendor contracts remove any exposure to the company‘s supplies. c. Commenting on the bargaining power of the company with the vendors (esp. key supplies). Based on the vendor selection process covered under the head of processes.

d. Purchase commitments. e. Review what are the alternate sources for supplies? f. Identify the extent to which the close substitutes are available for the company‘s supplies.

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3

THE PROPOSED TRANSACTION/TRANSACTION SUMMARY Objective of this section is to provide a summary of the transaction that the client is proposing to enter into with the target company. ? ? Background on client – one paragraph. Background on target company – one paragraph.

Example: YY is exploring the possibility of acquiring controlling stake in XX by purchasing the entire shareholding/possibility of merging with XX. The consideration of this transaction would be paid in cash to the majority shareholders of XX. The consideration of this transaction will be paid through a combination of cash and allocation of XX shares. ? ? Put a diagrammatic representation of the pre- and posttransaction structure. Give an explanation of the steps involved in : ? ? Changes in shareholding structure. Transfer of funds.

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4 KEY FINDINGS/EXECUTIVE SUMMARY

Objective of this section: This section on executive summary covers the major findings of the Due Diligence process. The findings are classified under four major heads, namely: ? ? ? ? Deal Issues. Valuation Issues. Representation Issues. Post closing Issues.

Each finding should be quantified specifying the impact on the valuation of the firm. Also, recommendation should specify the appropriate steps the client should take, (example: adjust valuation/ask for assurance and warranties from the target company‘s management, etc.). Before discussing the key issues for XX in the transaction, provide a summary of the financial statements of the Company during the review period (in the next slide).

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A summary of the key issues arising pursuant to the financial due diligences should be provided in the following manner: The discussion should proceed in the following order: ? ? ? Summary of the financial statements. ―Summarized table‖ of the issues. Detailed discussion about ―Issues‖ in the order given above.

The discussion of the individual issues under the relevant sub-heads should proceed in the following order: ? Past treatment and the current status of the item under consideration. Use a table if detailed break-up is to be discussed. ―Issue‖ with the reasons. Give details of the reasons. Implications. Propose a going-forward treatment.

? ? ? ?

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– 4.1 DEAL ISSUES Deal issues are strategic business issues that depend upon magnitude of risk and likelihood of its occurrence. Clearly and precisely specify the issue along with recommendation. The issues highlighted should reflect the key risks/challenge the transaction faces. For example: ? Are our findings consistent with the client‘s views concerning: ? ? ? ? ? Examples ? Continuity of Business: – – – Dependence on Suppliers: Single supplier/customers Contract Terms: Yearly renewal of contract, termination clauses, continuance of Business. Geographical Rights: The Company has limited distribution rights against contrary understanding of the buyer. ? ? ? Issues concerning the basis for pricing. The key reasons for doing the deal. The key assumptions about the target business. Key areas of value creation. 4.2

Gaps in Business Plan: Expense estimation and expenses not accounted for compared with historical trends and peer group benchmarking.

VALUATION ISSUES Valuation issues affect the valuations of the target company and should be quantified to bring out the impact on the valuation of the target for helping the client complete the deal at the best price. Clearly and precisely specify the issue along with recommendation. For example: ? ? Issues concerning the basis for pricing. Possible negotiation points: ? ? ? Value of earnings/assets. Maintainable earnings. Key value drivers.

Recommendations for each issue, if any.

Highlighting additional upside. Maintaining value on sell side. Recommendations for each issue, if any.

Examples ? Adjusted Profitability The table below provides a few examples regarding proposed adjustments on profitability for [Quarter No., Year]:

Achievability of Projections: – – Revenue Projection Gaps – contracted vs not contracted. Project Delivery and Capacity: Company‘s ability to manage the number of projects as projected in the Business Plan.

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?

Net Adjusted Assets (insert information) The table below provides a few examples regarding the reported net assets as at [Month Date, Year]*: (insert information)

A few examples are given below: YYY should evaluate the following assurances and warranties to be appropriately included into the relevant transaction documents for the proposed merger/transaction: ?

Completeness of Documents Assurance that all documents (loan agreement, supplier contracts, financial statements, other documents, etc.) provided during the period of review, along with the translations, were accurate and complete in all respects.

? ?

Give details for each adjustment to the profitability and the net assets, separately. The details should proceed in the following steps: ? Past treatment and the current status of the item under consideration. Use a table if detailed break-up is to be elaborated. Details of each adjustment with the reasons. Implications and explanation of how the proposed adjustment amount has been calculated. Propose a going-forward treatment. ?

Contingent liabilities Representation that there are no contingent liabilities, apart from the one disclosed in the financial statements for FY XX. Further, an assurance must be sought that any contingent liability that arises in future pertaining to the period before the proposed merger will not impact the dynamics for the current transaction and will be to sellers‘ account.

? ? ?

4.3

REPRESENTATION Issues regarding assurances from the target company‘s management are covered under this head – there will be a few issues during a Due Diligence of which we cannot be sure due to non-availability of data or limited nature of a due diligence review. ? Highlighting key risk areas and recommendations to mitigate. For example: – – Sale and purchase agreement. Deal structuring. ? Receivables and other current assets The receivables and other current assets outstanding as of the transaction date are good and recoverable. Impact of any losses on recoverability of the same post completion of transaction on ? Operational liabilities All provisions and liabilities for the six months ending [Month, Year] or a later transaction date have been adequately provided for as at the transaction date. All loans and related charges have been appropriately disclosed.

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the agreed valuation, will be reimbursed to YYY by the existing shareholders of XXX. ?

? ?

M&A plans Tax effect on strategy

Outstanding debt All required approvals from lenders/creditors, for the proposed transaction as required per the terms of the agreement will be obtained by XXX prior to the completion of the transaction.

Some examples are given below.

The following issues highlight the post acquisition issues and focus for YYY: ?

?

Contractual liabilities Any contractual liabilities and consequential damages with regard to contracts entered or services provided prior to the transaction date, will accrue to the account of existing shareholders of XXX. Closing audit YYY should insist on a closing audit as at the transaction date, to evaluate the level of recoverability of all current assets and receivables, to ensure existence of all fixed assets and inventory and also to ensure that appropriate provision for all liabilities has been adequately provided. ?

?

Approvals pursuant to the proposed transaction Assurance that the proposed transaction will not have any impact on existing customer contracts and other agreements like supplier contracts, distribution contracts, leases, etc. Appropriate approvals as required will be obtained prior to completion of the proposed transaction. Fixed assets verification The company does not have a defined process for physical verification of fixed assets. Further, the assets are not tagged and the fixed assets register does not specify the location of the same. YYY should insist on performing physical verification and reconciliation of fixed assets capitalized in the books as at the transaction date as part of the closing procedures. ?

4.4

POST CLOSING This section covers the post merger/transaction completion issues that the company might face. ? ? ? ? Our view as to key areas to focus on post acquisition to secure and build value. Resolving short-term weaknesses. Mitigating risks. Longer term issues:

Insurance Coverage The Company does not have a policy on insurance coverage and presently there is no insurance cover taken on fixed assets by the Company. YYY should assess the risk profile of the Company and assess the risk on the continuity of the business in case of an exigency

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and ensure that high-risk assets have an adequate insurance cover.

5

ANALYSIS OF PROFIT AND LOSS ACCOUNT The objective of this section is to provide a broad overview of the revenues and costs of the Company and their trend over the review period. A summarized profit and loss account for [Period 1, Period 2, and Period 3] is given below:

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(insert information)

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Broad analysis of the Profit and Loss account to be covered here. For example: ? ? ? Highlight major movements in revenues/gross profits and the reasons for the same. Highlight major movement in costs and the reasons for the same. Highlight major movement in profits and the reasons for the same.

The following sections would analyze the revenue, key costs and margins of the company.

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5.1

REVENUE The purpose of this section is to analyze the basis of the target‘s revenues, in order to evaluate the surety of revenues in future. For this purpose the trend in revenues over the review period should be analyzed (as per the details of the subsections) to identify: ? Are there any one-time sales included in revenues, (sales which will not accrue in future)? Are there any sales of fixed assets included in revenue? What are the major growth drivers in increased sales? Are the revenues booked correctly? Review the trend in revenues and classify the break-up of revenue into various heads. Enumerate new customers added and old customers lost for the review period and the reasons for the same. Identify any changes regarding any aspect of revenue recognition policy during the review period and the reasons for the same. Inquired whether any sales of goods/services has been made to the identified related parties, if any, ensure that such transaction has been made at the arms length price and according to the disclosed policy of the Company. Also

ensure that such transaction is not prejudicial to the interest of the acquirer.

[This space has been intentionally left blank] Key ratios for the review period to be computed and analyzed: Service Industry: Revenue per average billable professional Revenue per billable professional man per month Revenue to capital employed Revenue to fixed assets Revenue to salaries of billable professional

? ? ? ? ?

Manufacturing Industry: Revenue per product Revenue to capital employed Revenue to fixed assets Revenue to raw material consumption

?

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?

Overview of Revenue Cycle Review the following to ascertain when revenues are recognized in the books and the accuracy, completeness, recording and presentation for revenues. For example: ? ? ? ? ? Pricing approval. The accounts executive recording the client P.O. should not be engaged in recording the sales. Procedures in place for follow-up of questions raised by customers. Proper reconciliation of P.O., invoice, dispatch order and acknowledgement by customer. Mention the MIS reports and evaluate the accounting system and procedures used by the management for tracking revenues and inventory cost data and its ability to produce reliable (revenue and gross/contribution profit) data by product, product line, customer, end user, distribution channel, market or target sales region, sales representative, or other pertinent categories. Also, review any significant changes in the systems and procedures during the review period that would affect the comparability of data. ?

?

Analyzing the impact of such change in the future cash flows.

Product-wise/vertical-wise break-up of revenue Provide the following information along with the analysis to highlight the major contributors to the revenue and their growth: ? ? Obtain a table on the product/service-mix of the company giving the product/service wise revenue break-up. Trend Analysis: Identify whether the company is selling higher margin products/services or moving towards lower margin products/services and the reason for the same. Analyze the level of growth in volumes and the drivers of the same. Analyze the pricing policy and rates charged.

? ? ?

Discounts and sales returns policies Review the discount and sales return policies to evaluate whether significant discounts were given to increase sales and whether the customers are dissatisfied with the product leading to a high level of sales returns by: ? Ensuring completeness and review the extent of adherence to the company policy to ascertain whether any short-term benefits were derived by compromising the long-term benefits. Obtaining and reviewing the policies for accuracy of accounting for deductions to revenues, such as returns, rebates, and payment/volume discounts. Reconciling gross to net revenue. Claw back policy: “Claw back policy” refers to the reversing of discounts by the company in case of sales returns. Identify the sales returns pertaining to discounted sales and evaluate

?

Revenue Recognition Policy Review the accounting policy of the company with respect to revenue recognition and ensure its consistency, accuracy, recording and completeness during the period under review by: ? Ensuring that such revenue recognition is in accordance with the principles enunciated in relevant accounting standard and other guidance materials. Scrutinizing whether there is any change in the accounting policy during the period under review and analyze whether such change is in accordance with the GAAPs followed (and according to the principles followed in the particular industry).

?

? ?

?

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whether the discounts were reversed subsequently and the same has been adjusted in the books. ? ? Trend Analysis: Identify any significant changes in discounts and sales returns. Compute the percentage of discount, rebates and returns with respect to gross sales over the review period and inquire about the reason of differences.

?

Geography-wise break-up of revenue In case the company is functioning in different locations, provide a geographical break-up of revenue along with any significant changes to evaluate particular regions/locations where the revenue has increased/decreased, significantly by: ? Providing a table of sales revenue from different locations along with its percentages with respect to its net sales over the review period. Analyzing the revenue generated from different subsidiaries/ branches in case the company has subsidiaries/branches. Providing a table on the break-up of sales into domestic sales and exports. Trend Analysis: Movement in the sales mix (geography) and the reasons for the same.

? ? Customer-wise break-up of revenue Review customer-wise revenue share and ascertain any excessive dependence on few customers. Discuss the dependence of the company on the top X customers by: ? Computing the percentage of the sales to major customers (top X) with respect to sales over the review period and inquire about the reason of differences. Discussing any revenue – sharing arrangements. Review the implication of the variable and fixed components and any commitments arising from such an arrangement. Trend Analysis: Identify the trend in customer purchases and inquire about the reasons for any significant increase or decrease in customer orders. Reviewing whether repeat sales happen regularly or rarely. Discussing with the management any long-term revenue commitments with the customers. ? ? ?

Average realization by product/by service Discuss the pricing mechanism and the average margin earned by each product/service over the review period and inquire about the reason of differences by enquiring about: ? What has been the change in the product mix over the years – whether the company is moving towards products which earn a higher margin? If not, then the reasons for the same. In case of Service Company, analyze average realizations per billable hours and what has been the movement over the years.

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? ?

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5.2

SUMMARY OF CONTRACT Briefly comment upon the adequacy of the agreements and contracts for the following: ? ? ? ? If the target has long-term contracts with the customers. What is the term of the contract? What are the termination clauses in the contracts? Do the contracts specify a minimum performance level and what is the recourse (performance fees) available with the customer? What have been the performance fees target has paid over the years? Do contracts include any financial or operational commitments? Are these onerous contracts? ? ? ? ? ? Break-up of costs Provide the following with the relevant analysis to achieve the above-mentioned objectives: ? A summarized break-up of table detailing the costs of the Company along with percentage break-up of the total cost. Summary of costs per functional classification (marketing, finance, etc.), different cost heads (materials, salary, etc.). Understanding of purchase policies and procedures, including purchasing practices, delivery, consignment policies, usage patterns, physical and accounting controls, and costing and valuation procedures. Trend Analysis of movement in costs over the review period, for each cost item. Any purchases of goods/services that has been made from the identified related parties. If any, ensure that such transaction has been made at the arms length price and according to the disclosed policy of the Company. Also ensure that such transaction is not prejudicial to the interest of the acquirer.

? ?

5.3

COSTS Objective of this section is to: ? Rationalize the costs incurred by the company, i.e. look at the trends in costs over the years and find out specific reasons for the same. Is there an increase in the level of costs incurred by the company? For example, the company has projected sales to increase on the basis of increase in operations? To support its increased operations, the company has already taken additional premises on lease. Ensure that increased lease costs have been factored in and appropriately adjusted from present profits. Ensure that provision for liability has been made correctly on the basis of monthly/annual costs incurred by the company.

?

The analysis of costs will vary depending on the type of industry: a. Manufacturing Industry b. Service Industry

?

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?

Break-even Analysis ? For the service/manufacturing industry, obtain a summarized table breaking different costs into fixed and variable (along with the respective percentage of the total cost). Link these costs with the total cost used in calculating the average margin earned by product/service. Based on the table given above, do a break-even analysis for each service/product line. ?

each raw material and the number of units produced should tally with the total cost of raw material. Identify the raw materials comprising a significant part of the overall cost of raw materials based on the analysis done in the previous table and review them as part of ―Suppliers‖ in the Framework. Compute raw material consumption per unit of output on a monthly basis over the review period and justify the reasons for the variation. Input/Output Analysis: Compute input/output ratio on a monthly basis over the review period and justify the reasons of variations, if any, after considering the impact of seasonality and wastages. Evaluate any major shifts in the consumption and wastage trend of each raw material over the review period. Compute raw material consumption with respect to turnover on a monthly basis over the review period.

?

?

An example of minimum analysis of some major cost elements is presented below:

?

Manufacturing Industry: ? ? Raw materials: ? Obtain an understanding of purchase policies and procedures, including consumption practices, delivery, consignment policies, and usage patterns, physical and accounting controls, and costing. Obtain a table giving information about the type of raw material, number of units of the respective raw material, per unit cost of the raw material, total cost of the raw material and the respective percentage of the total cost of the respective raw material in the overall total cost of raw materials. The overall total cost of the raw material should tally with the cost reflected in the profit and loss account. Obtain a table for each raw material: the units purchased, units consumed, wastage, percentage wastage. (An attempt should be made to cover a significant portion of the raw material cost). Through this table determine the number of units and the cost of each raw material that is part of each unit of output. Ensure that the total of the product of the cost per unit arrived at, for ?

Labor: ? Obtain a schedule of the different components of the labor costs for example, wages, costs of temp labor, employee welfare and benefits, etc. for each labor category, i.e. unskilled, semi-skilled and skilled. Using the number of laborers for each category as base, calculate the average salary per labor for each category. Compute labor consumption per unit of output on a monthly basis over the review period and justify the reasons for the variation. Compute input/output ratio on a monthly basis over the review period and justify the reasons of variations if any after considering the impact of seasonality. Compute labor consumption with respect to turnover on a monthly basis over the review period.

?

? ?

?

?

?

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?

Evaluate any major shifts in the cost per labor hour and number of labor hours per unit of output for each labor category over the review period. Obtain a table giving information about labor in terms of labor category (i.e. number of unskilled, semi-skilled and skilled labor; cost per labor hour for each labor category; number of labor hours utilized for production for each labor category; total cost for each labor category; respective percentage of the total cost of each labor category in the overall total cost of labor). The overall total cost of labor should tally with the cost reflected in the profit and loss account. In the table discussed above, also determine the number of labor hours for each labor category that is part of each unit of output. Ensure that the product of the labor hours per unit arrived at for each labor category, cost of each labor hour for each labor category and the number of units produced should tally with the total cost of labor. The overall total cost of labor should tally with the cost reflected in the profit and loss account. Perform a trend analysis in labor efficiency, input/output ratio during the review period and justify the reasons for the variation.

? ?

The overall total cost of the stores and spares should tally with the cost reflected in the profit and loss account. Compute per unit cost of consumption of stores and spares and compare it with the periods under review and inquire about the reasons of variation, if any. Ensure that the product of the cost per unit arrived at and the number of units produced should tally with the total cost of stores and spares. Ensure that the spares which can be used only for a particular machine and the use of which is irregular should be capitalized along with the respective fixed assets and depreciated in the balanced useful life of that asset. Obtain a list from management of such type of spares and also review whether there are proper internal controls to ensure proper recording mechanism of the same. Evaluate any major shifts in the consumption and wastage trend of each stores and spares over the review period, compare it with the previous accounting periods and inquire about the reasons for the same. Identify the stores and spares comprising a significant part of the overall cost of stores and spares and review them as part of ―Suppliers‖ in the Framework. Obtain a complete list of slow moving stores and spares as on date for all the review periods and their current status. Also inquired from the management personnel, the policy of making a provision on such stores and spares.

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? ? Stores and spares: ? Obtain an understanding of purchase policies and procedures, including consumption practices, delivery, consignment policies, usage patterns, physical and accounting controls, and costing. Obtain a schedule giving information about the type of stores and spares, total cost of the stores and spares raw material and the respective percentage of the total cost of the respective stores and spares in the overall total cost of stores and spares.

?

Packing and transportation: ? Obtain a table giving information about the type of packing material, number of units of the respective packing material, per unit cost of the packing material, total cost of the packing material and the respective percentage of the total cost of the respective packing material in the overall total cost of packing materials.

?

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? ? ?

The overall total cost of the packing material should tally with the cost reflected in the profit and loss account. Compute the total cost of packing material and transportation with respect to sales and justify the reasons of variations. Obtain a table for the consignment dispatched on a timely basis and all the list of the transporters along with their chargeable rates. The chargeable rate into the dispatched quantity should tally with the total freight outward cost. Obtain a table for each packing material: the units purchased, units consumed, wastage, percentage wastage. Through this table determine the number of units and the cost of each packing material that is part of each unit of output. Ensure that the product of the cost per unit arrived at and the number of units produced should tally with the total cost of packing material. Evaluate any major shifts in the consumption and wastage trend of each packing material over the review period. Identify the packing materials comprising a significant part of the overall cost of raw materials and review them as part of ―Suppliers‖ in the Business Analysis Framework. Identify the main modes of transportation of finished goods. Obtain a table for transportation giving information about the mode of transportation, per unit cost of transportation, number of finished goods transported by each mode, the total cost of each mode of transportation. The sum of the total cost of transportation should be equal to the overall total cost of transportation as per the profit and loss account. Identify the percentage of loss (breakage/wastage) in the transportation of finished goods and discuss with the management any significant changes in the same, over the review period and perform a trend analysis for the same.

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Power and Fuel: ? Obtain a table giving information about the kind of energy sources being utilized for production, number of units of the energy source, per unit cost of the energy source, total cost and the respective percentage of the total cost of the respective energy source in the overall total cost of power and fuel. The overall total cost of power and fuel should tally with the cost reflected in the profit and loss account. Compute per unit cost of consumption of each of the source of fuel on a monthly basis over the review period and justify the variations if any. Obtain a table for each energy source: the units purchased, units consumed, wastage, percentage wastage. Through this table determine the number of units and the cost of each energy source that is part of each unit of output. Ensure that the product of the cost per unit arrived at and the number of units produced should tally with the total cost of energy source. Input/Output Analysis: Evaluate any major shifts in the consumption and wastage trend of each energy source over the review period. Identify the energy sources comprising a significant part of the overall cost of power and fuel and review them as part of ―Suppliers‖ in the Framework.

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Servicing Industry: ?

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Salaries and wages: ? Obtain an understanding of the internal control system in respect of employee recruitment, chargeability, billing policies, payment, increment and bonus policies and procedures.

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Obtain a schedule of the different components of the salaries costs for example, basic pay, bonus, retirement employee welfare and benefits, etc. for each employee category. Using the number of employees for each category as base, calculate the average salary per employee for each category. Evaluate employee cost per chargeable hour during the period under review and inquire for the reasons of variations if any of the same. Evaluate the number of chargeable hours and billing rate on a project basis, compared it with the previous accounting periods and inquire for the variations if any. Evaluate the total cost of salary and wages with respect to the income from services, compared it with previous accounting periods and inquired for the variations if any. Obtain a table giving information about employee chargeable hours in terms of project handled during the period under review, number of employees utilized on that project, and total number of projects. Perform an overall reconciliation of the total head count after taking into account the new joiners and resigned employees. Evaluate the revenue per employee, considering average number of employees, for the review period and inquire about the reasons of variations if any.

[This space has been intentionally left blank] ?

Legal and professional expenses: ? Obtain a complete list all the professional and legal consultants mentioning the purpose for which company has incurred the expense over the review period. Scan the ledger accounts of all such legal and professional consultants to find any unusual entries. Perform a trend analysis of such expenditure consultant-wise and inquire about reasons of variations.

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Interest, commitment and other financial charges: ? ? ? ? Obtain a complete list all the loan accounts detailing the interest rate, purpose of loan, maturity and repayment amount. Overall interest calculation should tally with actual interest paid/payable during the review period. Perform a trend analysis of such expenditure during the review period. Ensured that interest and other ancillary costs (borrowing cost) incurred on the assets which takes a substantial period of time (more than a year) to get ready for its intended use must be capitalized along with the cost of such assets. (Accounting Standard for capitalization of borrowing costs).

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Rent: ? ? ? Obtain a list of all the agreements along with the name of landlord, details of the property and monthly rent charged. Overall rent calculation (monthly rent * number of months) should tally with the total rent calculation. Map the security advances extended for rents, etc. as part of loans and advances.

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Other major expenditure: There are certain cost items that are peculiar to a particular service industry and a thorough understanding of the same, is essential for a complete analysis of costs. For example, ?percentage of per download revenue to the content provider‘ in the telecom sector. General guidelines for the analysis of such costs are given below:

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Obtain an understanding of the internal control system in respect of authorization, segregation, recording, accuracy and completeness of such expenditure. Obtain a schedule of the different components of such expenditures. Using the number of employees for each category as base, calculate the average expenditure per employee for each category and perform a trend analysis. Evaluate the total cost of particular expenditure with respect to the income from services, compare it with previous accounting periods and inquire for the reasons, if any. Provide a table giving information about expenditure incurred in terms of project executed during the period under review. Perform a trend analysis of such expenditure and inquire for the reasons of variances.

6

ANALYSIS OF BALANCE SHEET Objective of this section: ? All the assets represented in the balance sheet are actually in possession of the company and have been valued correctly at the amounts mentioned. All the liabilities have been correctly accounted for in the books and no liability has remain unaccounted. A summary of the balance sheet and key ratios of the Company is provided below:

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(insert analysis)

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Overview Present a broad analysis here based on the balance sheet presented above. The analysis should include the major trends in assets and liabilities over the years along with reasons for the same.

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Analysis of key ratios ? ? ? ? ? ? Current ratio Working Capital turnover ratio Debt – equity ratio Total asset turnover ratio Return on Equity Return on Investment

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Discuss the major reasons for the change/no change and the impact of on liquidity, solvency etc. for each individual ratio. ?

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Review any unusual delays in the debit/credit of significant amounts. Obtain an understanding of the target‘s policies and procedures with respect to billing, credit and collection, revenue recognition, confirmation and methods for establishing accounts receivable provisions. Analyze the composition of the accounts receivable balance (such as trade receivables, affiliates, or other). Discuss with management and obtain an understanding of the components of the balances. Inquire about pledged (or sold/factored/securitized, etc.) receivables, if any. Analyze a listing of customers with non-standard payment terms. Table depicting aging of debtors with detailed analysis on debtors exceeding the credit period offered by the company as close to the DDR date as possible. Management explanations regarding non-receipt of money from the debtors. Understand the details of dispute in payment/claims filed by customer. Ascertain the scope of similar dispute being raised by other customers. Compare the balance of each significant receivable account with the comparable balance for the preceding period. Review any significant or unusual fluctuations. Understand the collection policies and credit terms as per the respective contracts and analyze details of changes in the same, if any. Receivables in number of days for each product/service and discuss the reasons for the difference in DSO, if any, and link it to the collection policies and credit terms given above. Also analyze the impact of seasonality.

Accounts Receivables Analysis: ?

Thereafter, each Balance Sheet item has to be analyzed individually by providing and analyzing the following. ?

Assets ? Bank and Cash Balances: ? Break-up of bank balances as on FY XX and YTD YY. The break-up should give: i. ii. Currency Denominations. Reason for holding cash/bank balance in currency denominations other than the denomination in which the firm does its regular business. Restrictions on use/committed funds, if any.

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iii. ?

Discuss the cash receipts and payments policies and procedures, including cash management policies and systems, authorization controls, segregation of duties, overdraft/letters of credit facilities, compliance with loan and overdraft agreements, and other unusual credit facilities. Comment on review of bank reconciliations statements of various banks as on FY XX and YTD YY. Reasons for any un-reconciled items. Review bank reconciliation statements as of the historical balance sheet dates for significant accounts. Inquire from management as to the nature of unusual reconciling items. Review any unusual amounts (for example, round amounts, repetitive amounts, unreasonably large amounts, etc.).

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(Company name)

Financial Due Diligence Report - Sample

? ? ? ?

Major customer-wise analysis and subsequent realizations. How often does the management reconcile debtor accounts with the balances provided by the customers? Analyze debtors that are doubtful of recovery and reasons for the same. Understand the provisioning policy of the Company for doubtful debts/written-off debts and analyze details, movement and adequacy in provisions. Select significant debtors against which provision has been created and identify whether the provision was created as per the policy. Analyze a roll-forward analysis of the target‘s allowance for bad debts (and each of the other receivable reserves such as credit memos, discounts, returns, etc.) including opening balance, write-offs, recoveries, provision, other, and closing balance.

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Analyze the components (units and amount) of inventory (raw materials, work-in-process, finished goods, in transit, consigned, pledged, and inventory provisions) by product category, location, etc. Understand the reasons for significant and unusual fluctuations or trends in the inventory components. Read the listing of inventories to assess their realizability (including inventories in transit, in distribution channel and lying with third parties). Obtain a reconciliation statement between the general ledger and subsidiary ledger, if any. Discuss the procedures and controls over counting inventories – frequency, completeness, etc. Obtain an analysis of book-to-physical inventory adjustments. Consider the implications of the nature and causes of these adjustments. Analyze inventory turnover and inventory days‘ cost of sales. Investigate significant fluctuations and trends, including the impact of seasonality. Analyze inventory provisions. Obtain an understanding of the target‘s procedures for identifying excess, slowmoving, obsolete, and other inventories deemed to be unsaleable. Consider the adequacy of inventory provisions in light of management‘s responses and our knowledge of the target‘s business and the industry in which it operates. Aging analysis of the inventory (raw materials, WIP, finished goods, stores and spares). Compare inventory quantities on-hand to the inventory requirements of the target‘s sales backlog/projected sales. Identify any items where the inventory quantities exceed the projected (or historical) sales, and inquire management about their plans and ability to dispose of the inventory and the expected impact of such actions on sales, gross profit, and operating income.

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Related Party: ? ? Obtain nature and details of related Company dues/receivables in the review period. Analyze the movement in balances in the review period to understand the nature of transactions between parties.

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? ? Inventory: ? Obtain an understanding of inventory policies and procedures, including purchasing practices, delivery, consignment policies, usage patterns, physical and accounting controls, and inventory costing and valuation procedures. Break-up of inventory into raw materials, work-in-progress, finished goods and stores and spares. ?

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Financial Due Diligence Report - Sample

?

Ensure that valuation of inventory is being done on the basis of principles in relevant accounting standard pertaining to valuation of inventories. Ensure that inventories are valued at lower of cost and net realizable value. Ensure that no obsolete items are present in stock at higher than scrap value. Assess if unrealized profit is eliminated on inter-company inventory transactions. ?

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Identify significant past due balances and inquire of management regarding the status and collectibility of these amounts.

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Fixed Assets: ? Obtain a summary of fixed assets – gross value, net value, accumulated depreciation for each asset category over the review period. Calculate the fixed assets turnover ratio and compare it with the competitors. Depreciation policy – whether in line with the industry standards and what is the expected useful life of assets. Also review any significant changes made to the policy over the review period. Review calculation of depreciation in FAR and ensure its consistency to the depreciation policy. Discuss internal controls over fixed assets such as physical verification procedures – frequency, coverage, etc. Review any old/fully depreciated assets, their current use and expected replacement. Obtain the capital budget (including both maintenance and growth cap-ex) for the remainder of the current fiscal year and for the next one-to-five years, as available. Inquire of management regarding the methods used for preparing capital budget, the nature and purpose of significant projects and the discretionary vs. firm nature of the budget. Analyze fixed asset additions, including the nature of such items (maintenance vs. growth cap-ex, for example). Inquire of management regarding recurring annual maintenance cap-ex levels/requirements. Ensure costs that the provisions of relevant accounting standard on depreciation, tangible and intangible assets, borrowing costs, and impairment of assets have complied.

? ? Other current asset: ? Analyze the components of prepaid expenses and other current assets. Assess the nature and expected realization of such assets. Compare the level of prepaid expenses and other current assets to those in prior periods and understand the reasons for significant variations. Detailed analysis and break-up of major advance recoverable amounts including reason for variances over the review period. Comment on the aging, recoverability and confirmation of each current asset in the break-up. For example, ―Advances to Employees:‖ a detailed breakup to be obtained from the HR department along with reasons for unadjusted advances. Also, comment whether the employees are still with the organization or have already quit. Match this list with the list of employees received from the HR department, which will be covered in the section on HR. Also ensure that prepaid expenses are being amortized properly. Gain an understanding of the nature of the accounts, reason for advancement and the reason for any unusual or significant items. ? ?

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(Company name)

Financial Due Diligence Report - Sample

?

Capital work-in-progress (CWIP) – present status, aging, expected date of installation, benefits due, etc. Analyze the roll-forward analysis of CWIP. Analyze fixed asset disposals, including net profits and losses. Understand the reasons behind significant disposals and whether replacement assets were purchased. Also determine whether the profits and losses on such disposals were included in earnings. Inquire of management about the existence of any idle or otherwise impaired fixed assets, including plans to dispose of such assets. Impairment of assets during the period under review – year, amount, reason for the same, etc. Obtain any third-party appraisals of fixed assets and assess the impact of any significant findings. Analyze repairs and maintenance expense. Understand any unusual fluctuations in repairs and maintenance expense, such as one-off or infrequent expenditures and whether any ―catch-up‖ spending is required. Obtain an analysis from the target‘s management as to the amount of ―catch-up‖ spending (repairs, maintenance, and cap-ex) required for the target‘s productive capacity to be restored to good operating condition. Capital commitments – amount, years, funding source, etc. Any assets that do not have any value to the firm (or have scrap value) but are still valued in the books. Idle, unused and surplus assets. Details of terms and accounting practice for leased/hired assets and brief about the respective leasehold agreements. Details of charges or lien created against any fixed assets through guarantees or loan arrangements. ?

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List of all properties owned or operated that are connected to the business with details of their book values, usage, title/lease and rent details. Obtain, read and comment on the adequacy of insurance policies for assets. Obtain and read any technology transfer agreements entered by the Company to analyze future outflows and restrictive covenants.

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Deferred tax asset: ? ? ? Break-up of deferred tax asset including deferred tax asset policy of the target. Comment on reversibility of deferred tax assets shown in the balance sheet. Compute the percentage of deferred tax assets with respect to Earnings Before Tax and current tax over the review period and justify the reason of the variation. Analyze the future taxable projections of the target company as to reverse the deferred tax assets. Ensure the provisions of the relevant accounting standard for deferred tax has been complied with while recognizing the deferred tax assets and liability.

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Other Assets: ? ? ? Obtain detailed break-up of heads comprising other assets. Comment on the aging and recoverability of each asset in the break-up. In case of intangible assets/miscellaneous expenditure, assess if the same to be adjusted from the net assets in case they do not generate future benefits.

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(Company name)

Financial Due Diligence Report - Sample

?

Investments: ? Obtain and analyze the schedule of investments and Obtain details of amount, nature of investment including when the investment was made and the maturity of the same. Determine the nature of the relationship with the Company and the Company‘s management and the ownership interest in each. Obtain an understanding of investment policies and procedures, including purchasing and disposal practices, physical and accounting controls and valuation procedures. Discuss with management about the valuation principle and the present value of investments and based on the discussion analyze the provision for decline in value of the respective investments. Obtain management‘s assessment of the on-going benefit of the Company‘s investments and joint ventures. Comment upon whether any investments have been over valued as compared to their market or net realizable value. Ensured that while valuing the investments the relevant accounting standard for accounting of investments has been complied with. Compare the level of current and long term investments to those in prior periods and understand the reasons for significant variations. ? ? ?

extending terms or taking discounts), and cut-off policies and practices. Obtain and understand the details of current liabilities as at [Period 1, Period 2 and Period 3]. Identify the payment terms under different contracts with the suppliers. Analyze the aging of the accounts payable by supplier. Scan the accounts payable trial balance for any unusual items (for example, debit balances) and inquire as to the reason for any significantly past due balances. Discuss with the management, reasons for creditors aged more than the allowable credit period. Evaluate whether the company is facing a cash crunch in paying off the creditors. In case of delayed payment by the company, is the company required to pay late fees. If yes, at what rate/amount. Internal controls in the form of confirmations from trade creditors with respect to periodicity, coverage and accuracy. Analyze accounts payable days with respect to cost of sales on a monthly basis. Inquire about significant fluctuations and trends, including the impact of seasonality. Obtain and analyze a summary of the components of accrued and other current liabilities at the historical balance sheet dates included in the review period. Obtain an understanding of the nature of these accounts, the methods used to calculate the balances and the reasons for significant fluctuations in the account balances. Compare the level of creditors to those in prior periods and understand the reasons for significant variations.

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Liabilities ?

Creditors: ? Inquire about accounts payable policies and procedures, including terms (payment terms, use of forward contracts or letters of credit, etc.), payment practices (such as

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(Company name)

Financial Due Diligence Report - Sample

?

Provisions: ? Inquire about accrued liabilities‘ policies and procedures, including payment practices and cut-off policies and practices. Obtain and understand the details of accrued liabilities as at [Period 1, Period 2 and Period 3]. Compare the provision and the respective ending balances for the review period with the comparable amounts for the preceding audit period. Review significant or unusual fluctuations. Inquire about status of the closing balances of the provisions for previous accounting periods. Compare the level of provisions and accrued liabilities to those in prior periods and understand the reasons for significant variations. ? ? ? ? ? ?

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Working capital finance Others

Analyze details of outstanding amounts, current interest rates, periods and loan covenants. Obtain and read bank facility letters for encumbrances on assets and bank confirmations. Obtain and read details of any corporate/personal guarantee extended. Read, analyze and summarize major loan agreements covering period of loan, purpose of loan, interest rate, termination clause, option of early exit, payment terms, security deposit, etc. Benchmark with other industry players to verify the loan terms at which they can receive loan from the market. Repayment schedule – committed cash payments in future for current debt and how does the company plan to generate funds for repayment. Compare the level of secured loans and unsecured loans to those in prior periods and understand the reasons for significant variations.

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Secured and Unsecured Loans ? Obtain details and terms of working capital loans and other financing from banks and other parties with their respective year-wise repayment schedule. Obtain and read the debt agreements and analyze the salient terms including,
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Other Current Liabilities: ? ? ? ? Obtain detailed break-up of other current liabilities. Analyze every account head in detail to ensure that all the liabilities have been accounted for at the correct amounts. Explain reason for variance in balances for the period under review. Ensure that all liabilities have been accounted for in the books, (example: bonus to employees, gratuity, dividends/commission to management staff, ESOPs etc.).

Repayment, Repayment prior to maturity, Change in control and other restrictive covenants, and Future debt cost.

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The debt agreements/contracts would include:
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Term debt Lease finance

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(Company name)

Financial Due Diligence Report - Sample

?

Obtain details of ?Off Balance Sheet‘ Liabilities (such as leases), if any.

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Does the target have a cash based business (for example, retail) – tends to mean more predictable cash flows. Number of customers - few customers could mean high bad debt exposure. Analyze working capital (by component and in total) by month for the two most recent years and interim period. Understand the reasons (including unusual/non-recurring items) for significant trends and/or fluctuations noted. Analyze short-term debt balances (overdrafts, revolving credit, etc.), if any, in conjunction with working capital to determine the extent to which the target relies (and/or can rely on) short-term debt to fund working capital needs. Calculate average (and minimum) working capital for the trailing 12 months (or other period as appropriate)— typically based on the provisions of the working capital purchase price adjustment mechanism as defined in the LOI/Sale and Purchase Agreement. The calculated average (and minimum) working capital should usually exclude unusual/non-recurring items as noted per our analysis. Analyze key working capital ratios by month for the two most recent years and interim period; key ratios include accounts receivable days‘ sales outstanding, inventory days‘ cost of sales, accounts payable days‘ cost of sales. Identify and inquire of the reason(s) for significant trends and/or fluctuations noted.

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Shareholders Equity: ? ? Obtain a table summarizing the equity position of the company as at each balance sheet date. Explain details of fresh capital raised or buy backs and reasons for the same. For example, to fund cash losses incurred by the company in operations, to fund working capital requirements, to undertake planned CAP-EX expansion and how the company would fund its future requirements. Provide details on ESOP, if any – summary of outstanding options, etc.

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Accumulated Losses: ? ? Provide table detailing the accumulated losses, if any, for period under review. Explain the main reasons for the loss in any financial year. Also explain if the loss resulted in net cash outflow from operating activities. ?

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Working Capital: The following points need to be considered while analyzing the working capital requirements of the target: ? ? ? Increase in trading will generally result in increases in working capital. What have been the changes in key ratios, debtor/creditor days, etc.? Is stock seasonal? ?

Contingent Liability: ? Ensure that all contingent liabilities have been appropriately included by the company, namely workmen compensation claims, guarantees, etc. Brief description of all contingent liabilities and update the status after last audited accounts.

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Financial Due Diligence Report - Sample

?

Review all the show cause notices and demands received by the company during the review period.

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Understand principles of renting out business assets, real property, etc. from one group company to another. Obtain and read copies of any agreements concerning rent of business assets, real property, etc. Understand the basis and principles for group companies‘ rights to use other group company‘s intellectual property, including patents, trademarks, licenses, etc. Obtain and read copies of any agreements concerning the right to use other group company‘s intellectual property. Obtain details regarding maturity, security pledged and principles for establishment of terms on loans between group companies. Obtain and read copies of loan agreements between group companies, including installment and interest terms. Obtain and analysis intragroup running accounts, including interest terms, security, etc. Understand if the company and/or any of its subsidiaries own/control shares or similar in companies or entities in lower tax jurisdictions. Obtain an understanding of mergers and de-mergers of companies within the group last X years and current year. Obtain details as to whether the mergers and/or demergers have been claimed as tax neutral. Obtain and understand details of any remission of debt by, converting of debt to equity by and/or cessation of business activity of the company or any of its subsidiaries

[This space has been intentionally left blank] ?

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Related-Party Transactions: ? Inquire from the management regarding the existence of the related parties, their relationships with the company and nature of transactions entered during the review period. Obtain understanding of the internal controls system in place with respect to identification, disclosure, recognition of transactions and confirmation of balances - periodicity and accuracy with the related parties. Understand the principles for pricing of transactions between group companies. Understand the practice of the arm‘s-length principle in connection with inter-group transactions. Understand whether documentation exists that confirm the prices used are in accordance with the arm‘s-length principle. Understand whether the company or group has developed a transfer pricing strategy. Obtain confirmation of balances of all the related parties as on date. Perform a trend analysis of all the transactions with the related parties and inquire for the reasons of variances. Obtain nature and details of related Company dues/receivables and account listing of these dues/receivables in the review period. Obtain and understand whether all transactions between group companies are governed by written agreements, and if not reasons for the same. ? ?

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(Company name)

Financial Due Diligence Report - Sample

7

CASH FLOW ANALYSIS The objective of the cash flow analysis is to ensure that the company‘s operations are generating enough cash to fund present operations and fuel future growth. Perform an overall analysis on cash movement. For example, the entire cash generated from operations is being invested back in operations for further capital expansion, etc.

The table below summarizes the consolidated Cash Flows for XXX: (insert analysis)

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Provide a brief analysis of the following: ? Cash Flow from Operating Activities: ? ? Explain the movement in cash over the years. Also explain whether the company is able to meet its working capital requirements through funds generated internally.

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Cash flow from Investing Activities: ? ? Explain whether the company is going through a phase of capital expansion and is adding more fixed assets. Explain if the company is funding its cash requirements by selling of its fixed assets.

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Cash flow from Financing Activities: ? ? Explain the sources by which the company is financing its capital expansion – through equity or through debt? Comment if the company is financing its shortfall in cash due to operations through equity or debt.

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(Company name)

Financial Due Diligence Report - Sample

8

LIMITED REVIEW OF PROJECTIONS Review of management projections aims to give an understanding of the underlying basis of management‘s projections and evaluate the applicability of the assumptions used for projecting future revenue. ? Projections ? Understand the business ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ? Focus on the ?Big Picture‘ before examining the detail. What does the business do? What are the key drivers of the business?

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Review the numbers ? ? ? ? Ensure that the P&L, cash flow and balance sheet are integrated. Check that the arithmetic works. Reconcile fixed assets, cash, reserves and other balances. Are the numbers and the assumptions consistent?

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Review the funding and covenants. Establish level of headroom. Sensitivity analysis. Qualify any limitations of scope. ? ? Caveat any conclusions. Representation letter from the management of the target company.

Basis of preparation Why were the projections prepared? What level of review were they subject to? Forecasts or targets? Zero base or incremental? Are they imposed targets? ?

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Obtain a summarized table of the Budgeted vs. Actuals made by the organization.

Historic accuracy of budgeting To assess how good management is at forecasting. Assumptions ? Review underlying assumptions used in revenue projections made by the organization. Compare the same with historical figures and industry benchmarks and comment on achievability. Analysis of how much revenue is already contributed in the financial year vs. how much is assumed. Review underlying assumptions used in major cost projections made by the organization. Ensure that any costs that we anticipate will be incurred in the future but have not been so applied.

Understand and challenge the assumptions Obtain the assumptions supporting the numbers. Compare to historic results. Consider macro-economic assumptions. Consider results of commercial due diligence. Challenge management on achievability. Are there ―one-offs‖ in the historic numbers?

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(Company name)

Financial Due Diligence Report - Sample

9

HUMAN RESOURCES The objective of Human Resource analysis is to provide information about the human resource capital of the Company and to evaluate the efficiency and effectiveness of the same. Enquire and provide information about any benefits, liabilities etc. not being accounted for, or not being made part of the overall transaction, for example, severance packages. ? ? Turnover ? ? ? Organizational Structure ? ? ? ? ? Organization chart. Summarized table of the hierarchy in the organization. Different grades/positions in the organization. Number of resources at every grade. Ensure that the above is in-line with the information given in the background and introduction. ? Employee Benefits ? Employee benefit schemes. For example, ESOP scheme, medical insurance, leave encashment, etc. (The ESOP scheme information should match the ESOP scheme discussed under ―Shareholders Equity‖). Incentive/compensation schemes. Contribution/benefit plans for employees. Any default in making statutory contributions to respective authorities. For example, provident fund, gratuity, ESI, superannuation fund and the corresponding impact on the organization. ? Attrition rates. Review the record of the reasons given and any significant changes in the rate. Identify any particular periods during which there was a sudden increase in attrition and seek explanation for the same. Analysis on movement of people in top management and enquiry as to its movement. Inquire about any similar movements scheduled in future. Evaluate the ―Severance Packages‖ and other payments made to key employees leaving the organization.

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Employees ? ? ? ? ? ? ? ? Head count per function, segments, grades, etc. Hiring process and sources of hiring. Educational qualification of the work-force employed by the organization. Age composition of the employees. List of key employees of the organization. Summary of sample employee contracts/contracts with key employees. Summary of ―Bench Employees‖ and the cost implications of the same. Pending labor/employee disputes, if any.

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(Company name)

Financial Due Diligence Report - Sample

? 10 OTHERS Other issues that need to be considered from the deal perspective are mentioned under this head, namely: ? ?

Process controls.

Contract Summaries ? ? ? ? ? ? ? ? Date of the contract. Parties to the contract. Term of the contract. Fees received/paid – how decided, payment terms, what is the recourse in case of default, late fees, etc. Obligations of different parties to the contract and recourse the other party has in case of default. Liability clause. Termination clause – whether allowed or not. Exceptional clauses.

Control environment - Comment on the following: ? ? Review key processes, level of controls existing (manual, automatic, preventive, detective, etc.) IT environment, controls, etc.

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MIS Reporting ? ? ? ? Frequency. Kind of reports generated (exceptional reports generated). What all areas do the reports cover, namely revenues, profitability, attrition rates, seat utilization, etc. Review process and the reporting structure.

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Technology ? ? ? ? ? ? Kind of software. Purpose. Dependence on IT. Application controls. Sophistication. System controls. [This space has been intentionally left blank]

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