Due diligence is an essential process of health checking when working with, or representing clients for future investments. From an accounting perspective, it's been traditionally important to consider a variety of factors throughout the process, including capitalisation, valuation, revenue, competition, and more importantly: risk.
Lifting the floorboards of a new potential client or client investment can make for some surprising findings, but it’s essential to draw out potential flaws in business, and weed out any vanity metrics that create a false impression of company performance. But, with delivery times ranging from days to months, is it possible to both streamline and strengthen your due diligence processes at the same time?
Read on to find 5 tips on improving your client due diligence process, and help mitigate risks for both your business, and your clients investment portfolio.
There are a number of key steps to consider when unpicking clients or client investments through your due diligence checks, and identifying the areas you need to cover, and in what order, is the perfect place to start.
The initial investigation of a business should cover the high-level organisational goals, objectives, opportunities, operations and risks. Outside of initial client meetings with senior stakeholders, it’s important to do your own investigations too to uncover any potential contradictions or leaky pipes in company finances, and the motivations behind organisational decision making.
Analysing financial information is the bulk of the due diligence process. From physically auditing legacy documentation and balance sheets, to creating a secure Virtual Data Room (VDR) to access digital documentation - you need to cover all bases to create a full 360º verification and investigation.
While gathering your information you need to understand the data by evaluating the outcomes as they appear. Ask yourself questions to help with data evaluation, like: Are there any red flags that need deeper investigation? Does expenditure match inbound revenue? What level of financial risk is the business at?
Create a report that summarises the data that you have gathered and your findings, including any areas of the business that are at risk, and highlighting financial areas that are in need of improvement. As well as a comprehensive health check of a potential client, or for the clients future investments in new markets.
From data gathering to transaction analysis, creating the perfect strategy for a client due diligence process is no easy task, factor in a new-world views of Environmental, social and governance (ESG) conformance that are becoming increasingly integral, 2022 is the right time to start improvising your due diligence process to account for new regulations.
In 2019, the EU adopted the European Green Deal, with the aim to achieve carbon neutrality by 2050. As early as 2023, organisations are expected to implement and report on ESG drives that positively impact gender equality and pay gaps, environmental impacts, human rights, bribery, anti-corruption, and diversity.
There is also an increased pressure on investors to make sustainable investments, and many countries in the EU are bringing in new laws to ensure that businesses are moving forward to one common goal. France, for example, passed a new law in 2021, requiring large French-owned companies to ensure at least 30% of its senior executive staff to be represented by women, meaning a gender breakdown in due diligence is now common practice in this area.
A critical part of the due diligence process is reviewing the assets and liabilities of the target client or companies through a balance sheet examination. It’s important not to get bogged down in the amount of long-term debt a company has, and to look past it towards the business model the company employs to decipher whether the company is capital intensive, or whether they operate with employment at a skeleton level, minimal equipment, and ideation.
If you’re looking for a quick-win tip when analysing the ups and downs of finances through assets, liabilities and stakeholders, the footnotes that traditionally accompany financial statement and annual report documents is a good place to start. Footnotes are used to narrate business decisions and comprehensively explain peaks and troughs in financial performance, and can give insight into whether any fluctuations are due to product launches, misspent capital, resource troubles, or other issues.
Customer due diligence is nothing without perspective, and comparing factors like market position, company size and similar business models or ESG practices will provide a micro-analysis of the competition, and will give you just that.
Looking at the margins or two or more similar sized companies within the same industry can be an indicator of their performance. Directly comparing metrics like the debt-to-equity ratio oir price/earnings to growth (PEG) ratio, as well as the overall revenue should give you a reasonable idea of the end market and product (or service) demand, thus better informing you of the longevity and market position of your client or future investment.
Due diligence is, in its entirety, a process that determines both the benefits and risks of a potential client or investment. Highlighting the risks are important, but assessing these risks in terms of size and quality are arguably more so.
An easy way to determine whether further action or investigation is needed is through a yellow/red flag risk warning or risk matrix, which highlights the potential consequences of absorbing these risks into future decision making, giving full transparency of the due diligence results. Informing customers of risks in this transparent way can highlight the impacts decisions could have for clients, whether harming their financial position, or even strengthening negotiation power and price reduction during transaction.
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