Introduction:
The following is a list of questions as part of the overall company due diligence focusing on gathering documentation for Finance/Accounting. The outcome of this investigation is to validate the accuracy of the records as part of the overall company due diligence process.
Due Diligence Definition:
Due Diligence is the verification process of information and its associated documentation to ensure a reasonable individual "that they get what they are paying for". When buying, selling or forming a joint venture it is very important that the books and records are verified and tested to ensure the historical financial results are validated. If your company has a team of professionals who have experience in multiple transactions and a detailed checklist to follow that is probably an exception to the rule, most companies due these type of transaction infrequently. Therefore, it is recommended that due diligence be a coordinated effort with members of the company and an outside firm who has experience with the due diligence process.
The following are examples of the information to be assembled from key members of the management staff as part of the due diligence process.
FINANCIAL DOCUMENTS
a. Accounting Controls and Policies
• Overview of the Company's accounting/finance department and responsibilities by employee.
• Description of major accounting policies in place and any changes over the last five years (revenue recognition, fixed assets, A/R reserves, inventory obsolesce, accruals, etc.). Please note any polices which may be controversial.
• Description of differences in accounting policies and procedures for interim versus year-end results.
• Overview of the accounting policies and controls in place regarding revenue, purchasing, R&D and cash.
• Sales/credit terms and conditions. Documentation of policy on rebates, cancellations, discounts, etc. Description of product pricing.
• Purchasing policies and procedures.
• Purchase order terms and conditions, including samples of all forms of purchase orders, invoices, etc.
• Accountant's management letter or controls observation summary for the last five fiscal years.
• Procedures for costing jobs.
• Internal audit reports issued for the last five fiscal years.
• Summary of the Company's cash management system (forecasting, budgeting, etc.) and procedures.
b. Financial Statement Information (please provide information in Microsoft Excel if available)
• Audited financial statements for the last five fiscal years, including accountants' report.
• Internal financial statements for the last five fiscal years on an annual basis and the last two years on a monthly basis.
• Correspondence with outside accountants pertaining to special consulting projects or disagreements over any accounting issues.
• Detailed internal financial records (i.e. general ledger summary by major account) for the last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim (by division and consolidated).
• Summary of adjustments to reconcile from internal financial records to audited financial statements for last five fiscal years.
• Monthly management package, including financial statements and explanatory comments (e.g. variances from budget standards, performance highlights, etc.) for the last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim.
• All auditor's letters and opinions for the Company. Auditors' reports to management concerning internal accounting controls and procedures and other matters and any management responses thereto, and internal memoranda (particularly internal audit or regulatory compliance memoranda) concerning the Company. Internal audit reports to management or the Board of Directors.
• Copies of all outside corporate and/or subsidiary valuations for all other purposes, performed during the past five years.
• Copies of all federal and state tax worksheets including book vs. tax differences, tax accruals, etc.
• Identify and describe all contingent liabilities not reflected on the Company's financial statements, including, but not limited to, the following: a) Contracts and agreements, b) Price re-determination or renegotiation, c) Sales subject to warranty or service agreements, rebates or performance guarantees, d) Product liability, e) Unfunded pension plan liability, f) Equal opportunity matters, g) Environmental matters.
• Management's letters together with any reports, letters or correspondence prepared by accountants of the Company, if any.
• Schedule describing any ongoing tax disputes, together with copies of revenue agents' reports, correspondence, etc., with respect to pending federal or state tax proceedings regarding open years or items for the Company.
• Reports of any outside consultants, analysts or others concerning the Company.
c. Historical Operating Information (last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim)
• Sales (units & dollars) and gross margin analysis by key product or service.
• Sales (units & dollars) and gross margin analysis for the Company's 10 top customers for the last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim in Excel format. If a customer was in the top ten in one period, but not in the other please provide comparative totals. Please provide explanations for significant fluctuations between periods.
• Sales (units & dollars) and gross margin analysis by product and distribution channel.
• Details of any other income earned e.g. commissions, referrals, licensing fees, etc.
• Schedule reconciling gross sales to net sales, detailing discounts, cancellations, etc.
• Volume of inter-company sales. Description of transfer pricing methodology and elimination of inter-company revenues and profits.
• Analysis of any seasonal or cyclical sales patterns.
• Summary of research and development expenditures by project type.
• Cost of sales broken down by component. If not tracked separately, please provide detail of payroll costs, benefits, etc for job-related versus administrative (non-job related) salaries, and other expenses. Provide a separate schedule of subcontracting costs by line item within each cost category, (i.e., materials, labor, overhead) if applicable.
• Schedule of overhead costs by component.
• A schedule of the top ten suppliers and subcontractors (ranked by total annual purchases) detailing the amounts due them, what they supply, volume supplied and the relationship that is maintained. Please provide in Excel format for the last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim.
• Material contracts or agreements concerning business or services performed for, or materials supplied to, the Company or its subsidiaries.
• Selling, general and administrative expenses broken down by significant components. Explanations for significant fluctuations.
• Detailed breakdown of other income and expenses.
• Detail on any management proposed add-backs to historical EBITDA. Details on any other events/charges considered by management to unusual or nonrecurring, including development costs.
• Listing of all current customers.
• Listing of bids submitted (e.g. RFPs extended) including customer name, type of service, amount of bid, status (e.g. won, lost), if lost please include the name of competitor who won the contract and amount of winning bid.
• New product launches during past three years including: description of each product's revenue annually since launched; R&D expenditure relating to each new product launch; internal and external development expenses relating to each new product roll out.
• Planned new product launches for the next two years including: development expenses to date; estimated development expenses to complete; estimated revenue and it's timing.
• Identify any material warranty claims that have been made against the Company (or any partnership or joint venture involving the Company) and the resolution of any such material claim.
d. Historical Balance Sheet Information (last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim)
• Summary of banking relationships including number of accounts, amounts on deposit in each account and purpose of accounts.
• Summary of the Company's cash management system (forecasting, budgeting, etc.) and procedures.
• Please include borrowing base certificates on a monthly basis for past two years.
• Accounts receivable aging schedules for the last four quarters as well as reconciliations to the general ledger.
• Schedules of the top ten individual accounts receivable balances.
• Schedules of the ten largest accounts over 90 days with explanations for the delinquencies.
• Summary of credit memos, returns, and other adjustments.
• Summary of all accounts in dispute or in process of legal collection.
• Analysis of allowance for bad debts, including annual roll forward of the allowance (bad debt expense, write-offs).
• Summary of all receivables from other than normal trade accounts.
• Schedule of capitalized software costs by platform including amortization schedules. Schedule of capitalized R&D costs, including amortization schedules.
• List of all inventory by type, amount, age, location (please identify consignment, slow moving and obsolete inventory).
• Detail of inventory reserve calculations for the last five fiscal years, year to date for the most recent interim and year to date for the prior year comparable interim.
• Copy of last five physical inventory exams.
• Summary of property and equipment and accumulated depreciation broken down into category totals (i.e. land, building, equipment, etc. and location) as well as any PP&E additions or deletions.
• Schedule showing capital expenditures by category including description of significant items.
• List current or proposed initiatives/opportunities for sales growth or margin improvement or working capital improvements and the expected capital investment required.
• Details on any note receivables including a copy of the note, amount, duration, rate, payment terms, covenants, payment schedule and rationale for issuing the note. This includes both notes to trade and employees.
• Schedule of major prepaid expenses, deferred charges, "other" assets and liabilities providing a detailed breakdown and description of what is contained in each account.
• Accounts payable listing and reconciliations to the general ledger.
• Description of cancellation policy, calculation of reserve and past cancellation experience.
• Schedule of other accruals and liabilities (commissions, bonus plans, utilities, marketing programs and deferred revenue) with description of their calculation methodology.
• Schedule of long-term investments showing the name, percentage of ownership, original cost, basis at which stated and current market value.
• Schedule of long-term debt which includes security description, principal amount, interest rate, payment schedule, advance payment privileges or penalties, late payment penalties, renewal and conservation privileges, sinking fund requirements, principal repayment loans and other covenants.
• A listing of major leased facilities and equipment showing locations, annual rentals for the next five years, expiration dates, renewal options, ownership, square footage and age.
• A summary of property taxes for the last three years and evidence of payment.
• Summary of major outstanding commitments such as commitments for fixed asset purchases, advertising campaigns, construction, employment contracts and profit sharing and similar plans.
e. Forecasted Financial Statements (next five fiscal years on a monthly basis)
• Projected balance sheets and income statements.
• Projected cash flows.
• Projected capital expenditures.
• Detail of all assumptions used in projections, identifying key success factors.
• Business plan for each year for the past five years.
Conclusion:
The due diligence process is very financially oriented, but professionals in legal, tax, human resources, insurance & risk, sales and operations are typically involved in the process and responsible for difference areas of the validation process. Do not take the process lightly and do not assume the information being provided is correct without a through vetting and analysis to validate the accuracy.
