Encore, do you want more (FDD Analyses)?
Believe it or not, we left some stuff out of our More Than You Wanted to Know About Financial Due Diligence post. Financial Due Diligence (“FDD”) reports are tailored pieces of commissioned work. The scope changes based on numerous factor, including who is commissioning the work (buyer vs. seller), the budget, and a multitude of deal specific considerations (industry, deal size, etc.). Below are descriptions of a few additional common FDD analyses.
Reconciliations. FDD analysis usually starts by reconciling the trial balance data to the audited financial statements (or reviewed statements if there are no audited statements) to identify any material variances. It is the starting point for all the analysis and ensures the starting point earnings (i.e., EBITDA) is correct. It will also include other reconciliations, such as tying out the trial balance data to transaction or customer level databases.
Cash Proofs. FDD analysis sometimes includes a cash proof, especially in instances where the company being diligenced has not been audited. A cash proof typically consists of separate complimentary analyses, a proof of revenue and a proof of expenses. Sometimes only a proof of revenue is completed. A proof of revenue is where you attempt to reconcile reported revenue to the bank statement cash inflows. A proof of expense is where you attempt to reconcile reported expenses to the bank statement cash outflows. This can be a tedious exercise that almost always does not completely tie out exactly, but it is prudent to complete to guard against fraud or simply inaccurate financial statements (and the look stupid risk for investors).
Accounting & Finance Policies & Infrastructure. FDD often includes an examination and commentary (whether formally in the report and/or provided verbally to the client) on the infrastructure, systems, policies, and procedures of the accounting and finance department of the business being diligenced.
Customer / Segmentation Analysis. FDD analysis often examines revenue and profitability trends by customer, channel, product, SKU, or other segmentation that may better inform the quality of revenue and quality of earnings. This may extend to other complimentary analyses, such as price, volume, and mix analysis. Much of this type of analysis is performed at the transaction level. Some TAS / FDD groups have separate data analytics teams that may process customer or transaction level data in a more granular fashion.
AR & AP Agings. FDD analysis customarily examines accounts receivable (“AR”) and accounts payable (“AP”) agings, usually by customer and vendor. The AR agings attempts to identify potentially uncollectible receivables or slow paying customers, while the AP agings attempt to identify if the company is stretching any of its vendors, has any disputed AP, and if it is fully using payment terms extended it. Both aging schedules can have a Quality of Earnings (“QofE”) impact, a Net Working Capital (“NWC”) impact, and stretched payables could be considered a debt-like (“DDL”) item.
Industry Specific Analyses. FDD analysis may include certain industry specific analyses. For example, in SaaS or other subscription businesses, it is very common for FDD reports to closely examine such key performance indicators as annual recurring revenue (“ARR”) or monthly recurring revenue (“MRR”) in addition to gross and net dollar and customer retention. Multi-site retail businesses might have unit economic performance metrics, such as buildout capex, store ramps, breakeven and payback metrics, and same store sales growth (“SSSG”). In third-party reimbursed healthcare businesses, detailed gross vs. net revenue analysis by payor is common. Most industries have specific analyses that are customary and important to investors in those spaces.
