M&A Due Diligence: Accounting Diligence (Part III of IV)

The accounting diligence process examines the accuracy of the historical financial statements and assesses the forecasts.  When going to market, it is crucial to have accurate, consistent, and timely financial information that ties with the company’s operational data to avoid delaying the sale process.  Preparing for accounting diligence can be the most intensive step in the sale process, but it is necessary. Weak accounting (numbers and processes) will decrease the value of a company.

A company preparing to go to market must have monthly financial statements in GAAP, and if relevant to the company and industry, cash. Note that cash basis financial statements adjusted to GAAP at the end of the year only are not sufficient.  The monthly financials should reconcile to the company’s operational data, and such reconciliations should be reviewed monthly.  A best practice is to have a monthly Management’s Discussion and Analysis (MD&A) report reviewing the financial performance, a discussion of the factors driving the monthly results, and comparisons to prior periods. Not only will this help the organization better understand the financial results, but it serves a guide for discussing historical financials in diligence.

A company should have annual budgets and multi-year forecasts and compare monthly results to the forecasts.

A company preparing to sell should have an audit, not a compilation, by a public accounting firm. Colonnade recommends having at least three years of audited financial statements. In addition, a sell-side quality of earnings can support valuations based on non-GAAP financial statements and can validate significant adjustments to the financial statements.

A company should be able to close its financial statements by mid-month following the last day of the reporting month. Often, accruals and journal entries are used to meet this timing requirement. During the sale process, potential buyers expect timely updates to the financial information, and it reflects poorly on the company if it is unable to produce such statements.

For more on Accounting Diligence, please listen to Middle Market Mergers and Acquisitions podcast by Colonnade Advisors, episode 005: https://coladv.com/podcast/