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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