Due Diligence

1. Background and Business Processes Including Internal Control Environment

Understand the Target’s business with particular focus on its:

• History and background of the Target
• Share capital history and potential equity dilutions
• Marketing, sales and distribution channels
• Key locations, production facilities and products offered

2. Basis of Preparation of Financial Statements

• Obtain an understanding of the basis of preparation of the financial statements, accounting software used, MIS reporting frequency (along with understanding of KPIs tracked), accounting closing process
• Obtain, analyse and comment on reconciliation of the management accounts to the financial statements
• Obtain an understanding of the Target's significant accounting policies with specific reference to revenue recognition, inventory valuation and COGS

3. Quality of Earnings

Obtain an understanding of and comment on the quality of reported revenue and earnings with particular focus on:

• Revenue recognition
• Changes in accounting policies
• Evaluate provisions for inventory markdowns, sales returns, and discounts
• Recurring versus non-recurring transactions
• Adequacy of revenue/expenses accrual
• Nature of other income
• Proforma adjustments for events impacting future profitability

4. Revenue and Operating Profits

• Comment on the revenue and costs recognition policy (as per MIS and financials)
• Obtain an understanding, analyse and comment on the monthly/quarterly revenues and gross margins for the historical period
• Read agreement with top customers to understand key commercial terms and onerous commitments, if any
• Analyse accrual process including frequency of balance reconciliation

5. Procurement, Manufacturing Costs and COGS

• Read agreements with top suppliers to understand key commercial terms, minimum volume commitments, inventory storage and other onerous commitments, if any
• Analyse manufacturing costs like power and fuel, contract labour, production employee costs and comment on key trends. Analyse and comment on trends in inward freight / logistics cost

6. Selling, General and Administration (SG&A) Costs

• Obtain understanding of composition of Sales force (freelancers vs contracted) and read agreements to understand commercial terms. Analyse head count and compensation levels by different categories
• Analyze trends in fixed expenses including general and administrative costs and comment on any significant variations

7. Employee Costs

• Obtain an understanding of employee base (on rolls vs sub-contracted) and cost structure from the pay register including reconciliations
• Analyse head count, compensation levels by function and grade, and cost/ employee
• Comment on the movement in the number of employees and the average employee cost
• Obtain details of key components of other employee related costs such as employee benefits, staff welfare expenses, travel costs, training costs, and analyse trends therein.

8. Working Capital

• Analyse quarterly working capital trends (as tracked by management) during the historical period including average working capital levels. Discuss working capital funding.
• Identify the trade and non-trade working capital trends by segment for the historical period and understand the normalized working capital trends of the business.
• Analyse the aging of accounts receivables, accounts payable and inventory balance as at period end.
• Obtain subsequent clearance of receivables as at latest available date and comments on the historical collection trends.
• Understand inventory ageing profile and trends in inventory holding period and comment on potential mark downs on unsold inventory

9. Capital Expenditure

• Understand historical capex spend and comment on the significant additions / deletions during the historical period.
• Summarize planned capex spend and capital commitments at latest available balance sheet date, if any

10. Related Party Transactions

• Comment on the nature of transactions entered into with related parties historically
• Analyse the recoverability of related party balances at latest balance sheet date based on discussions with management

11. Commitments and Contingencies

• Obtain a list of significant claims, pending or threatened litigation pending at period end. Discuss with management their views on the likely outcome of the cases/claims.
• Inquire, obtain and comment on the following commitments and contingent liabilities including:
  • pending or threatened litigation;
  • capital commitments;
  • other contracts and

Tax Due Diligence (TDD):

 

Security of Information

 

1. Tax Compliance Status Review for all Federal, State, and Local Taxes

2. Review of availability of the appropriate Documentation/Records

3. A summary inspection of the tax returns filed for the past years (Form 1040, 1065, 1120)