Case Study- Due Diligence Reporting

Business Issue:

Case Study

Beechbrook Capital enlisted EFM’s services due to their increasing concerns of using the traditional financial due diligence reports being produced by the “top” accountancy practices. Their opinion was that the methods used by these practices were still being produced in the same format for the last 15 years or so, the reports were almost identical in format and presentation, Power Point slides, landscape format over 100 pages in length, and littered with disclaimers and non-opinions.

Whilst Beechbrook were reasonably comfortable with the underlying profits and free cash flows they wanted a financial director’s perspective of the day to day running of the finance function as well as an assessment of the senior management team and a number of key metrics which will be amplified below.

Background:

The company was a target of Beechbrook Capital, a venture capital debt provider aimed at sophisticated investors who expect returns >20% p.a. over a five year period. The target would be acquired using a mixture of secured debt and loan notes for the legacy shareholders as well as incentivising the current senior management team. Beechbrook would acquire 20% of the target company.

Challenge:

The challenges were to review current reporting systems and to check the accuracy of the management information produced and to ensure that the profits and cash flows produced were timely and accurate.

In addition, the logistics aspect of the business needed to be reviewed to ensure that imported goods from China were distributed in an effective manner.
Furthermore, a number of areas were flagged by Beechbrook that warranted further investigation which they felt were not adequately covered under financial DD. These included working capital forecasting, balance sheet review, completion accounts review, finance staff review , assessment of VAT return production, as well as key customers, key suppliers and Forex exposure.

Solutions:

For the review of financial data, I employed a mini audit approach in order to establish the accuracy of the management accounts produced.
I reviewed all of the Board packs produced before assessing the financial accuracy using analytical review methods over prior periods. I extrapolated this information to the working capital forecasts and completion accounts. After a thorough review and detailed discussions with the finance team, I was satisfied with their accuracy.

In tandem with the above, a review of the customer and supplier base was undertaken.
I found on the customer side that a strong sales ledger was in force. New customer/poor credit history cases were asked for 50% up front and the balance on delivery. The sale ordering system interfaces directly with the factory in China. Any customer changes would be fed directly to China, with additional charges being passed onto the customer.

The company sources all of its products directly from China. Two deliveries are made to Southampton docks, which is a short distance to the company’s warehouse.
A review of the logistics function demonstrated an organised and well run machine, with an orderly process of dispatching goods to the relevant customer.

The company has a significant exposure to US$. The key supplier is settled entirely in US$, and the company operates a method using a third spot, third options and a third using forward contracts.
This on balance seemed to work well since a review of the gross profit margins over the last 24 months would indicate a strong and consistent margin being achieved.

The VAT issues as highlighted by Beechbrook would appear to have been an isolated error produced in finance, which to be honest I felt that they were too embarrassed to admit to. I had to assess the strengths of the senior management teams in terms of style and leadership. Informal discussions were held, not only with the senior management team, but with tier two staff as well, which was met with positivity, with the staff enjoying the harmonious working environment.

Benefits:

Beechbrook were delivered a report that was produced on time and within the set budget, to a very good standard.
It cut short the clichéd house style of the accountancy firms, written in plain English at a small fraction of the costs charged by the leading accountancy practice.

EFM Expert: Michael O’Donnell