Purpose of Financial and Operational Due Diligence
The primary objective of FODD is to obtain a comprehensive understanding of the target entity’s financial position, operational health, compliance status, and potential risks. This process serves as a basis for:
– Evaluating the commercial viability of the acquisition
– Identifying potential deal-breakers or post-deal liabilities
– Planning integration and operational alignment
In essence, FODD functions as a critical risk-mitigation tool and a roadmap for strategic decision-making.
Preliminary Review: Business Profile and Background
Begin with a detailed review of the target entity’s history and operating model:
– Date of incorporation and corporate structure
– Nature of business and revenue model
– Key products/services or academic programs
– Management structure and operational processes
This information may be gathered through management interviews, corporate documents, and publicly available data such as websites, regulatory filings, and third-party databases.
Promoter and Management Evaluation
Understanding the people behind the business is fundamental:
– Background verification of promoters and key managerial personnel (KMPs)
– Review of their roles, experience, and governance practices
– Identification of any conflicts of interest or reputational risks
Financial Analysis: Historical Performance
A detailed examination of audited financial statements (typically for the last three financial years) includes:
– Profitability: Revenue, EBITDA, PBT, and PAT trends
– Solvency and leverage: Total liabilities, debt levels
– Cash flows: Realized earnings vs. book profits
– Segment-wise performance: Revenue contribution by product, service, or course
This analysis should be supplemented by a ratio-based assessment to evaluate efficiency, liquidity, and return metrics.
Key Financial Ratios
– Current Ratio
– Quick Ratio
– Debt-to-Equity Ratio
– Net Profit Margin
– Return on Capital Employed (ROCE)
– Working Capital Turnover Ratio
Statutory and Regulatory Compliance
Failure to comply with statutory obligations may result in significant financial and reputational liabilities. A compliance review should include:
TDS (Tax Deducted at Source):
– Timeliness of filing TDS returns
– Defaults, delays, and associated penalties
– Review of the TRACES portal for outstanding demands
GST (Goods and Services Tax):
– Filing compliance for GSTR-1, GSTR-3B, and annual returns
– Mode of tax payment (input credit vs. cash)
– Notices or demands pending on the GST portal
Labour Laws:
– PF and ESI applicability and compliance
– Timeliness of returns and payments
– Portal reviews for pending assessments or liabilities
Income Tax:
– Review of income tax portal for demands, scrutiny cases, or assessments
– Cross-verification with books of accounts
A comparative compliance chart highlighting due dates vs. filing dates is recommended for clarity.
Expense Analysis and Trend Identification
Identify and evaluate the top 10 expense heads over the last three years. The objective is to:
– Detect unusual or abnormal increases
– Identify potential areas of inefficiency or manipulation
– Understand the business’s cost structure
A year-on-year comparison, supported by percentage analysis, can help isolate outliers and uncover systemic issues.
Loans and Borrowings
A comprehensive review of active borrowings should include both secured and unsecured loans:
– Loan sanction letters, account details, and repayment history
– Interest rates and EMI schedules
– Outstanding balance and overdue status (if any)
This is crucial as any outstanding debt obligations will transfer to the acquirer post-transaction.
Trade Receivables and Working Capital Health
Outstanding receivables can significantly impact liquidity:
– Prepare an ageing analysis of trade receivables
– Identify slow-moving or doubtful debtors
– Assess the working capital cycle and cash realization timelines
A strong revenue number may be misleading if most sales remain unrealized.
Human Resource Review
Given that employees form a critical part of any acquisition, it is essential to obtain:
– A complete employee roster with date of joining and salary structure
– Details of statutory deductions such as PF, ESI, and TDS
– Verification of payroll compliance and employment contracts
This information facilitates post-acquisition integration and compliance continuity.
Pricing and Revenue Trends
For commercial entities:
– Review the price list of major products or services
– Identify year-on-year changes and margin implications
For educational institutions:
– Analyze course-wise fee structures and historical fee revisions
– Identify any concessional or scholarship-driven revenue adjustments
Areas of Concern and Risk Indicators
Summarize the key issues discovered during diligence:
– Statutory non-compliance or pending litigations
– Weak financial ratios or liquidity concerns
– Irregular expense patterns or related-party transactions
– Operational dependencies on few customers, suppliers, or staff
This section forms the core of the risk analysis for decision-makers.
Strategic Insights and Growth Opportunities
Alongside the risk evaluation, highlight:
– High-growth verticals or underleveraged revenue segments
– Operational inefficiencies that can be corrected post-acquisition
– Areas for value enhancement through integration
These insights help the acquiring entity plan strategic alignment post-deal.
Executive Summary and Decision Matrix
Conclude with a concise 1–2 page dashboard summarizing:
– Incorporation and business overview
– Financial highlights and ratios
– Statutory demands and compliance status
– Key red flags and areas of concern
– Strategic insights and overall recommendation
This summary enables the management to take a clear, data-driven call on the acquisition.
Conclusion
Financial and Operational Due Diligence is more than an evaluative exercise—it is a strategic enabler. It not only mitigates risk but also uncovers areas of potential, offering the acquiring entity a head start in integrating and scaling the business post-transaction.
At YKGGLOBAL, we approach FODD with precision, objectivity, and actionable insights—enabling our clients to acquire with clarity and confidence.
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