Verifying Historical Financial Data: A Guide to Financial Due Diligence for Business Acquisitions

Hey corporate warrior! Are you about to buy another business but kept up at night by the finance due-diligence? You're not alone. Verification of historical financial data can be particularly challenging for business owners, who often fear missing key details that at best could kill the acquisition; at worst could bring financial disaster down on their heads.

In this guide, we will cover the essential aspects of financial due diligence in mergers and acquisitions and how to validate historical financial information. Using this material will guide the career you have been yearning for all along, by validating the data failures, financial statement analysis, risks assessment, etc., that can lead to effective decision-making and avoiding expenditure loss.

Exploring Financial Due Diligence

Financial due diligence is the investigative process buyers go through to ensure they fully understand the financial health of a target company prior to completing an acquisition. This encompasses more than just a review of financial statements; it explores the systems, processes, and documentation underlying the numbers.

Why Historical Data Matters

The more accurately you understand your past finances, the better you will be:

• Check if the financial statements of the target company are accurate
• Look for trends and patterns in financial performance
• Evaluate the past financial performance of the company
• Identify any fraudulent or inaccurate financial practices
• Serve as a basis for future financial projections

Essential Elements of Financial Due Diligence

Data Validation

Data validation is done to double-check that the target company has submitted the financial information correctly. This involves:

• Reconciliation of securities purchases against source documents
• Ensuring consistency between financial periods
• Ensuring all business transactions are correctly entered
• There are no significant differences between what financials are reported and what is on record

Financial Statement Analysis

This includes a thorough analysis of the target company’s financial ratios, which includes:

• Income statements
• Balance sheets
• Cash flow statements
• Tax returns
• Budgets and forecasts

Identify trends, seasonal patterns, and anomalies which could signal financial health problems or opportunities.

Risk Assessment

Assess possible financial exposures such as:

• Contingent liabilities
• Unrecorded obligations
• Pending litigation
• Regulatory compliance issues
• Customer, vendor, or product concentration risks

What You Can Do to Verify Historical Financial Data

Collect and Organize Financial Documents

Assemble all the financial documents of the target company relevant to the investigation, such as:

• Previous fiscal reports
• Bank statements and records
• Invoice and payment records
• Contract agreements
• Tax documents
• Budget files

Perform Reconciliation Checks

Verify financial records against external sources for accuracy:

• Bank statements
• Vendor invoices
• Customer payments
• Tax filings
• Fixed asset registers

Analyze Financial Trends

Examine the historical data for patterns and trends:

• Revenue growth rates
• Expense patterns
• Profit margins
• Cash flow trends
• Seasonality effects

Accurate historical data is a key part of financial due diligence. So, if you are a QuickBooks user, then you might be required to learn how to correct prior balances in QuickBooks.

Conduct Interviews

Listen to some of the financial folks to learn:

• How they deal with financial processes
• Any known issues or discrepancies
• The reliability of financial reporting systems
• Any future financial responsibilities or prospects

Review Internal Controls

What internal financial controls does the target company have in place:

• How financial information gets recorded and reported
• Who has access to financial systems
• What checks are in place to avoid errors and fraud
• Documentation and implementation of financial policies and procedures

Common Mistakes to Avoid

Not Accounting for the Time Involved

Conducting financial due diligence properly takes time. Avoid rushing the process or skipping steps based on arbitrary timelines.

Neglecting Subsidiary Financial Statements

If the target company has subsidiaries, make sure their financials are also thoroughly analyzed.

Failing to Confirm Assumptions

Avoid blindly accepting the financial representations as true. Legitimate through documentation, always via analysis.

Not Getting the Right People Involved

Steps to take: Involve finance team members from both companies early on to facilitate a smooth transition.

Working with Professionals

Involve experts in financial due diligence for the acquisition of a business. They can:

• Provide objective insights
• Spot problems you could overlook
• Guide clients who are drafting complex financial instruments
• Use findings to help negotiate

FAQs on Financial Due Diligence

Q: How long does financial due diligence take for a business acquisition?

A: The process itself differs by the size and complexity of your company, but for mid-sized businesses, the average timeline is 4-8 weeks.

Q: What is the most common financial issue you find during due diligence?

A: Examples of common problems found include cash flow inconsistencies and liabilities not recorded in the books.

Q: Can financial due diligence be conducted remotely?

A: Yes; with appropriate documentation and secure data access, much of the process can be done remotely.