Financial Due Diligence

financial due diligence

WHAT IS THE PURPOSE OF A DUE DILIGENCE?
The purpose of a financial Due Diligence is to determine and evaluate the financial and economic situation of the entity under review in a process of buying and selling companies.

In general, the auditor responsible for carrying out due diligence should apply general and specific procedures in the financial area of the Company. The auditor in charge of such Due Diligence must understand the main activity of the company in all its business lines, products and services in order to be able to transmit them to acquiring party. In this audit process it is relevant to know the main customers of the entity and determine the degree of loyalty of them to the Company since, in our opinion, it is the most relevant asset and one of the main risks incurred by the potential buyer of the entity in case they leave the company after the acquisition.

In the accounting review process of the entity, the auditor should pay particular interest in the following aspects:
  1. Detect liabilities and contingencies not reflected in the financial statements of the company. To do this, you must circulate all the advisors/consultants of the Company and request the corresponding banking CIRBE.
  2. Identify all companies and persons of interest linked to the company under review, and analyze any transactions carried out between them.
  3. Of course, the auditor shall carry out an analytical review of the balance sheet and profit and loss account for the last three financial years.
  4. Evaluate the Company’s projections and budget of the next financial year(s).
The preparation of Due Diligence has the following objectives:
  • To reduce risks in a possible acquisition of an entity.
  • To detect all liabilities and contingencies of all kinds that the entity may have.
  • To Lay the trading bases between the buyer and the seller.
We also understand that the objectives of a Due Diligence are not:
  • To reduce the price of the transaction.
  • To assess the ethics and reliability of the seller.
VALUATION IN BUYING AND SELLING COMPANIES
WHY SHOULD A COMPANY REQUEST A VALUATION?
For good business management, it is advisable for a Company to measure or quantify the value of their business periodically. This will provide you with information about the usefulness of your business, and the outcome of that valuation will inform you of the degree of success of its management.

In general, proper management over time increases the value of a company, while an unfortunate one decreases it.

WHAT FOR AND WHEN SHOULD A COMPANY VALUATION HAPPEN?
Apart from the two basic and generic causes already mentioned, there are several specific reasons why a Company must undergo this assessment:
  • If we think about the possibility of selling the company, either as a whole or partially (ie. after the segregation of a branch of the business) it is obvious that the sale amount would reflect a prior negotiation between the buyer and the seller, but it should take into account this valuation.
  • If the Company requires equity to face new investments or is in a process of expansion.
  • In the event of a merger between companies to deal with the business with the advantages of the synergies achieved and a greater dimension, undoubtedly, the agreement of the redemption equation — correspondence between the shares delivered from each merged company and those received from those resulting from the merger — must respond to the valuations attributed to the companies participating in the merger.
  • In the case of an inherited transfer, where a Company director distributes the Company’s total assets among their heirs, this valuation will be useful in order to achieve economic equality between the different parts of the estate. Similarly, if in inheritance or in donation, a company is distributed among several heirs or donors, each party must be assessed to measure what each party is to obtain.
  • Finally, consider a dispute over the tax residence of an entrepreneur who has companies in Spain and abroad. Obviously, and in addition to their vital circumstances, in order to decide the State of your residence for tax purposes, the determination of your core of Interests and/or economic activities will require the valuation of their companies.
As you can see, the reasons that can cause the convenience or obligation, as the case may be, to ascertain the value of your company are multiple and varied.

HOW TO KNOW THE VALUATION OF COMPANIES?
To determine the value of your company, various techniques called valuation methods have been developed. Here are the highlights:
  • Net Accounting Value: The Company is valued by the difference between their total assets and the sum of their current liabilities. Its advantage lies in relying on objective data, directly from the Balance Sheet. It has therefore the drawback of disregarding the possible existence of latent capital gains/losses, and the avoiding present and future returns.
  • Cash Value: the company is valued by the net amount that would result in the assumption of its liquidation, which requires an estimate of the realizing value of its assets and a quantification of its liabilities. It overcomes one of the drawbacks identified in the previous method, but still does not consider present and future returns. Estimating the actual value of assets incorporates difficulties and subjectivity.
  • Profit Capitalization: a Company is valued by capitalizing at an updated rate on its annual profit. This method is already considering the current profitability (the profit obtained in the last closed financial year is usually chosen). Its drawback is that it projects towards the future the present profitability. The chosen rate significantly influences the resulting value.
  • Comparable multiples: a company is valued from the available information from transmissions of other similar companies (in sector and size). The existing ratios between the price paid and various parameters (sales, EBITDA, BAI, asset...) are calculated and applied to the same variables of the company being valued to obtain their possible price. Its advantage lies in the use of data from real and recent transactions. Its drawback is that the aforementioned data is not always available and that the comparability of them is not always adequate.
  • Currently, the method that is generally most accepted to value a company is that of the Discounted Cash Flows. Based on the available information, the expected net cash flows are estimated in the coming financial years (usually five) and the residual value at the end of the estimated period (usually as perpetual flow) is estimated. We use an appropriate discount rate, then calculate the current value of future flows which will represent the overall value of the Company. From this the amount of the financial debt is deducted (at cost), obtaining the value of the company's shares. The discount rate is obtained by adding to the risk-free rate several risk premiums (due to the country, the sector or the company itself). Its advantage is its close relationship with the entrepreneur's objective: to obtain future profits. Its drawback lies in the subjectivity required by estimating future flows. The discount rate applied influences the resulting value.
The combined use of various valuation methods is quite common, especially in the case of young or developing companies, as well as in Startups. 
TYPES OF BUSINESS VALUATIONS 
  1. Business valuation: To obtain the value of your company or business easily, quickly and cheaply, consult our professionals who will apply the most efficient and appropriate company valuation techniques for your business. 
  2. Assessment report : If you want to know how much your company or business is worth in detail, our experts will prepare an accurate valuation report for you.
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