Financial & Accounting Diligence

The foundation of any financial due diligence process is some proof that the financials the seller is presenting are accurate. We see far over 50% of sellers grossly misrepresent their profit in the initial materials provided to potential buyers. 

As a buyer – you don’t have access to their financial system directly.  Their accountant prepares their financials so they work for the seller and not the buyer.  And private company tax returns are typically meant to minimize tax exposure so they provide a floor on profits but seldom a robust view. 

Guardian’s Financial Due Diligence Process is Comprehensive and Includes:

  • Comprehensive Deep Dive & Review of Financials, Tax Returns, & Bank Statements: 3 years historical plus year to date monthly financials (income sheet, balance sheet, cash flow statement), 3 years of historical tax returns, & 3 years of bank statements.
  • Review of Non-Recurring Expenses: expenses that will not carry forward under the new ownership or that sellers suggest won’t carry forward but after review – are integral for the business to perform as it has historically.
  • Guardian Proof of Cash (“Guardian POC”): Reconciliation and tying out of the financials compared to the tax returns and then the bank statements. The bank statements are the most honest source of truth for financial due diligence.  However, most advisors won’t do the work of matching thousands of bank statement entries to what is shown in the financials.
  • Target Operating Model with Revenue and Profit Drivers: How does the business make money? What drives the revenue up and down. What drives the costs up and down.  The end result of a good Operating Model is given a set of assumptions – the model should be able to predict the revenue and profit generated by the business during a period of time.
  • A 5 Year Pro-Forma Monthly Financial Model: The first check is the historical financials.  But the ROI is based on future performance.  Based on the historical trends, Guardian will create a 5 year pro forma model to show what revenue and profits are predicted and what return that means for the buyer. 
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Review of Financials

3 years historical plus year to date monthly financials (income sheet, balance sheet, cash flow statement).  Guardian will also look back to the last downturn in the industry and see how the business did during that period.

 

Review of Tax Returns & Bank Statements

3 years of historical tax returns & 3 years of bank statements.  Both these statements are very important because each has some form of built in controls.  Taxes are audited by the IRS and bank statements are controlled by the bank and aren’t typically gamed.

Review of Non-Recurring Expenses

There are typically some expenses incurred under former ownership that will not be part of the business under the buyer’s ownership.  Sellers will push this number up in an “adjusted EBITDA” and it’s the role of Guardian to audit the seller’s lists of non-recurring expenses and taking out those that cannot truly be removed from the company without affecting the profits.

Proof of Cash

Arguably the most important of all areas of due diligence.  Before Guardian goes too far into any deal process – we reconcile & ensure that company provided financials match their bank statements.  A lot of games occur in and around PE deals and it’s critical to get a baseline.  Cash into the bank is revenue and cash out is expense – the difference is profit.  This is the first report that Guardian will deliver.

(Sample Proof of Cash Available – See Top of Page)

Business Operating Model

How does the business make money? What drives the revenue up and down. What drives the costs up and down?  How predictable are profits?  This process is included in both Financial & Operational Due Diligence as both elements are critical to building this out for the target business.

5-Year Pro Forma Projection

The investment’s returns will be based on future operations and this model takes the Operating Model, the sources & uses for the deal, the interest rates on debt, and returns a projected IRR.  The resulting 5-Year Pro Projection & LBO model will provide clear direction on the anticipated returns in several different scenarios.  

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