Due Diligence & Financial Red Flags Flashcards
(30 cards)
What is due diligence in M&A?
A comprehensive review of a target’s business, financials, and risks before completing a deal.
What is the primary goal of financial due diligence?
To assess the sustainability and quality of earnings, cash flows, and working capital.
Who typically performs financial due diligence in M&A deals?
Advisory firms like Deloitte, especially for buy-side clients.
How does due diligence protect buyers?
By uncovering financial, operational, and legal risks that could affect valuation or deal terms.
What’s the difference between due diligence and an audit?
An audit ensures compliance with accounting standards; due diligence evaluates business reality and deal risks.
Name 3 common types of due diligence?
Financial, legal, commercial.
What does legal due diligence focus on?
Contracts, IP, litigation, compliance, and legal ownership.
What does commercial due diligence evaluate?
Market positioning, competitors, industry trends, and customer quality.
What’s operational due diligence?
Analysis of processes, systems, supply chain, and scalability.
What kind of due diligence would review employee contracts and pensions?
HR or People due diligence
What is channel stuffing?
Pushing excess inventory to distributors to inflate short-term revenue.
Why is customer concentration a red flag?
Heavy reliance on one or few customers increases revenue risk.
What’s wrong with non-recurring revenue being included in EBITDA?
It inflates the value based on earnings that won’t repeat.
Why are overly aggressive EBITDA add-backs problematic?
They can distort true profitability and mislead valuation.
What is working capital manipulation?
Artificially improving short-term liquidity by altering receivables/payables/inventory.
What does “normalized EBITDA” mean?
EBITDA adjusted for one-time, non-operational, or non-recurring items to reflect sustainable performance.
Why is normalized EBITDA important in M&A?
Buyers pay based on sustainable earnings, not temporary boosts or distortions.
Give an example of a valid EBITDA adjustment.
Removing one-time litigation costs or M&A advisory fees.
Why is EBITDA not the same as cash flow?
It excludes capex, working capital changes, and financing items.
What happens if adjusted EBITDA is overstated?
The buyers overpays based on faulty assumptions.
Why is working capital reviewed in due diligence?
It directly affects purchase price through working capital adjustments.
What is a typical purchase price adjustment in M&A?
A change in deal value based on deviations from agreed working capital or net debt.
What does a cash conversion problem look like?
High EBITDA but poor cash generation due to slow collections or high capex.
Why are receivables aging reports important in diligence?
They reveal collection risk and potential bad debt issues.
