Page 329 - CA Final PARAM Digital Book.

Sri Rajan is above 80 years old and wishes to sell his proprietary business of manufacture of specialty
chemicals. Ceta Ltd. wants to buy the business and appoints you to carry out a due diligence audit to
decide whether it would be worthwhile to acquire the business. What procedures you would adopt
before you could render any advice to Ceta Ltd.?
OR
PB Ltd. entered into a deal with SV Ltd. for buying its business of manufacturing wooden products/ goods.
PB Ltd. has appointed your firm for conducting due diligence review and they want to know the cash
generating abilities of SV Ltd. What points will you check in order to ensure that the manufacturing unit
of SV Ltd. will be able to meet the cash requirements internally?
Answer Some of the significant key areas which shall be covered under the review are as under:
➢ Historical Background: The accountant should begin the financial due diligence review by looking

into the history of the company and the background of the promoters. The details of how the
company was set up and who were the original promoters have to be gone into, before verification
of financial data in detail. An eye into the history of the company may reveal its turning points,
survival strategies adopted from time to time, the market share enjoyed by and changes therein,
product life cycle and adequacy of resources. It could also help the accountant in determining
whether, in the past, any regulatory requirements have had an impact on the business of the said
company. This could, inter alia, include the nature of business(es), location of production facilities,
warehouses, offices, products or services and markets.

➢ Financial Projections: The projections for the next five years with detailed assumptions and
workings and the appropriateness of assumption used in the preparation and presentation of
financial projections. If the accountant is of the opinion that as assumption used by the company
are unrealistic, the accountant should consider its impact on the overall valuation of the company.

➢ Significant Accounting Policies: The accounting policies being followed by the company and the
appropriateness thereof is another key area. The impact of the recent changes in the accounting
policies in the recent past keeping in view its intention of offering itself for sale. The accountant
has to look at the main effect of accounting policies on the overall profitability and their
correctness. It is also quite important to ascertain significant accounting policies used by the
company, that changes that have been made to the accounting policies in the recent past, the areas
in which accounting policies followed by the company are different from those adopted by the
acquiring enterprise and the effect of such differences. Finally, examine whether the financial
statements of the company have been prepared in accordance with the governing statutory
requirements.

➢ Review of Financial Statements: An evaluation of the profit reported by the company would be
largely based upon its operating results. Any extraordinary item of income or expense that might
have affected the operating results would require close examination.

It is advisable to compare the actual figures with the budgeted figures for the period under
review and those of the previous accounting period. It is important that the trading results for the
past four to five years are compared and the trend of normal operating profit arrived at. The
normal operating profits should further be benchmarked against other similar companies. Besides
the above, and based on the trend of operating results, the accountant has to advise the acquiring
enterprise, through due diligence report, on the indicative valuation of the business. The exercise
to evaluate the balance sheet of the company has to take into consideration the basis upon which
assets have been valued and liabilities have been recognized. The net worth of the business has to
be arrived at by taking into account the impact of over/under valuation of assets and liabilities.

➢ Cash Flow: A review of historical cash flows and their pattern would reflect the cash generating
abilities of the company and should highlight the major trends. It is important to know if the
company is able to meet its cash requirements through internal accruals or does it have to seek
external help from time to time. It is necessary to check:
Whether the company is able to honour its commitments to its trade payables, to the
banks, to government and other stakeholders;
How well is the company able to turn its trade receivables and inventories;
How well does it deploy its funds; and
Whether any funds are lying idle or is the company able to reap maximum benefits out of
the available funds.
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