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Even if the auditors were thorough
in their approach, the financial statements that have been audited
will not provide the level of insight necessary to make an acquisition
or investment decision.
The approach taken by our specialists in performing financial due
diligence is to answer the questions that the auditors do not address.
Our approach is significantly more analytical than the typical audit
process and will ferret out the true operating performance of a company.
Here are a few examples of important issues that would not be analyzed
simply by reading the audited financial statements:
- Assume that revenues of a target company increased
5% in the past twelve months. What were the components of this
revenue increase? Are the higher revenues due to higher prices,
or higher volumes at lower prices, or lower sales at existing
divisions but higher revenues from newly acquired divisions?
- Assume that gross margins have increased in
the past year. Why the increase in margins when revenues have
remained flat? Is it because the company has become more efficient?
Or is it because it has changed its inventory valuation methodology?
Or did the company reverse some accounting reserves and therefore
boost reported earnings?
- Assume our client wants to buy a privately-held
company. How much of the company's expenses will cease to exist
because they are actually personal expenses of the selling shareholder
or are otherwise non-recurring?
- Assume our client wants to buy a division of
a publicly-held company. What will the division’s operating
performance be on a stand-alone basis?
We also find that not all auditors are as thorough as they could be.
Inexperienced audit personnel, staff turnover, competitive pressures
to keep audit fees (and therefore audit hours) low, and erosion of
auditor independence can all lead to a less than desirable audit approach
and issues “falling through the cracks”. Furthermore,
Generally Accepted Accounting Principles (GAAP) can sometimes lead
to answers that, while technically correct from an accounting perspective,
are not appropriate for the purposes of making investment decisions. |
