CA Kushwanth AVSR
Quick Summary
Due Diligence: Process of Investigation performed by investors into details of potential investment
1. Applicability: HILAR
- Hand Over of Charge within in the same group from one management to another management
- Recommendation for Investment
- Recommendation for advancing a Loan/credit
- Acquiring a controlling interest in a company
- Corporate Restructuring
2. Importance of Due Diligence: VINC
- Verify that transactions complies with investment or acquisition criteria
- Identify potential defects in the target and avoid a bad business transaction
- Gain Information for valuing assets and or Negotiating Price Concessions
- Confirm that the Business is what it appears to be
3. Areas/Classification of Due Diligence: FILE CPT
- Financial Due Diligence - Analysing books of accounts and financial information
- Information System Due Diligence - computer systems
- Legal Due Diligence - Review Legal Aspects
- Environmental Due Diligence - Studying the Entity's Environment
- Commercial Due Diligence - Evaluation from commercial and operational perspectives
- Personal Due Diligence - Entity's Personal Policies
- Tax DUe Diligence - Evaluate the Tax Affect
4. Scope of Financial Due Diligence: CHAPTERS
- Cash Flow - PreDICT
- Review Historical Cash Flows and their Pattern
- How well does it Deploy its funds
- Are there any funds lying Idle or is the company able to get maximum benefits out of the available funds
- Is the company able to honor its Commitments to the trade payables
- How well the company able to turn its trade receivables and inventories
- Brief History of the Target and Background of its Promoters
- Significant Accounting Policies
- Financial Projections
- Taxation
- Management and Employees
- Review of Financial Statements - COBRE (Similar to Cobra)
- Compare the actual figures with budgeted figures
- Objective is to look specifically for any hidden liabilities or over valued assets
- Benchmark normal operating profits against other similar companies
- Applicable Financial Reporting Framework
- Extraordinary Item of Income or Expense that might affect operating results
- Statutory Compliances
5. Examples of Hidden Liabilities: - SUBCELLS + WTP
- Company agreed to pay liabilities of Subsidaries
- Unfunded Gratuity/Superannuation/Leave Salary liabilities/ incorrect gratuity valuations
- Agreement to Buy Back shares at stated Price
- Letter of Comfort given by company not disclosed in the balance sheet
- Environmental Problems
- All Litigations
- Future Lease Liabilities
- Show Cause notice which has not matured into demands
- +
- Warranty Liabilites
- Tax Liabilities
- Pending Final Assessment of Customs
6. Examples of Over-Valued Assets: NEUROPIL
- Investments at Cost though NRV is lower
- Infructurous Project Expenditure
- Uncollectable Receivables
- Capitalisation of Revenue Expenditure
- Obsolete Inventories
- Obsolete Plant and Machinery
- Intangible Assets of No Value
- Litigated Assets and Property
7. Contents of a Due Diligence Report - SHOE + FRONTALS + SOFA
- Share Holding Pattern
- Brief History of the Target
- Objective and Scope of Due Diligence
- Executive Summary --> Introudction
- +
- Financial Liabilities
- Review of Components of Due Diligence
- Operating Results
- Net Worth
- Taxation and Statutory Liabilities
- Valuation of Assets
- Possible Liabilites on account of litigations and legal proceedings
- Management Structure
- +
- Swot Analysis
- Financial and other Obligations
- Comment on Future Projections
- Status of Charges, Liens, mortgages, Assets and properties of the company
- Suggestions on various aspects to be taken care of
Note: Above information is only informative and for remembering purposes only. For detailed information it is always advisable to refer ICAI Study Material
Also Read: Shortcuts to Remember Advanced Auditing and Professional Ethics - CA Final
FAQ :
Due Diligence is a thorough investigation process undertaken by investors to examine the detailed information of a potential investment.
Due Diligence is applied when there's a handover of charge within the same group, for investment recommendations, loan or credit advancements, acquiring a controlling interest, and during corporate restructuring.
The main areas include Financial, Information System, Legal, Environmental, Commercial, Personal, and Tax Due Diligence.
Financial Due Diligence involves analysing cash flows, reviewing historical data, assessing fund deployment, examining trade receivables and payables, understanding the target's background, reviewing accounting policies, projections, taxation, management, and financial statements for hidden liabilities or over-valued assets.
Examples of hidden liabilities include liabilities of subsidiaries, unfunded gratuity or leave salary obligations, undisclosed letters of comfort, environmental problems, pending litigations, and warranty liabilities.
Over-valued assets can include investments valued above their net realisable value, uncollectable receivables, obsolete inventories or plant and machinery, and capitalised revenue expenditure.
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