Sheldon Zimmerman

Wednesday, 25 February 2004 19:00

All in the details

Performing due diligence is an integral and critical part of any acquisition transaction. This is especially true in today's environment of corporate scandals and accounting fiascos.

Depending on the nature of the transaction, both the buyer and the seller will perform due diligence procedures, but clearly, the burden is much greater for the buyer.

By the time formal due diligence procedures commence, the acquirer or the investor has spent a considerable amount of time, energy and other resources in identifying the target, analyzing strategic considerations, formulating a high-level integration plan and arranging for financing. Oftentimes the information available in the public domain relating to the target is limited, especially if the target is a private company.

The due diligence process enables the buyer to see firsthand the operation of the target and obtain access to key employees, as well as additional financial and other records.

Since acquisitions can be risky, it is paramount that adequate time is allowed and the findings be utilized not only to finalize the integration plan and financing needs, but also to renegotiate certain aspects of the purchase price or other provisions of the purchase agreement.

The result of this process should give the buyer a degree of comfort that the original objective and reasons for pursuing the acquisition will be achieved. Alternatively, in some instances, the results of due diligence can identify issues that fall into the deal-breaker category.

If the transaction is being structured as an asset purchase with no liabilities being assumed, your focus will be to look at the nature and value of the assets being acquired. You will also look at the liabilities, but that review will be primarily to understand the nature of the business and assist in the formulation of the integration plan.

If the transaction is being structured as a purchase of common stock, you will still look at the assets, but will need to understand the liabilities of the company, including income taxes and contingencies, as those liabilities will be the responsibility of the purchaser unless specifically dealt with in the purchase agreement. Also critical is the assessment of the projections represented by the seller.

A point person should be identified so the results of the procedures being performed by the due diligence team can be accumulated by one person. Depending on the size and complexity of the transaction, a team of people from the acquirer might be more appropriate. The outside professionals will include, at a minimum, the attorney who has been assisting the acquirer with the negotiations and purchase agreement, as well as the company's outside accountants.

Depending on the complexity of the industry in which the target company operates or the risks associated with the assets or liabilities being acquired, individuals with specific specialties should be considered.

It is extremely important to identify critical risk areas associated with the transaction prior to the commencement of due diligence. In this manner, the team from the company and the outside professionals will be focused, which will reduce the likelihood of unnecessary procedures being performed and result in lower deal costs.

The following are some of the benefits you should expect from a properly planned and executed due diligence project. This list is not meant to be all-inclusive and will vary on a deal by deal basis.

* Validation of the original strategic acquisition assumptions

* Validation of the critical financial assumptions

* Validation that financing associated with the acquisition is adequate

* Identification of integration issues

* Potential renegotiation points to be considered

* An understanding of the quality of the employee base

* An understanding of the condition of the assets being acquired

Due diligence is not an insurance policy that will guarantee the successful integration and operation of an acquired company, but the chances of a good fit are much higher if the proper procedures are followed.

Sheldon Zimmerman (szimmerman@tbcpa.com) is a principal with Tauber & Balser P.C. in the Forensic Accounting & Litigation Services Group. With more than 30 years of professional experience, he has advised on mergers and acquisition, due diligence matters, fraud investigations and accounting irregularities.

Tuesday, 22 February 2005 14:00

Cash is king

The old clich "cash is king" has never been more true. Cash, or liquidity, is the lifeblood of any business. Having a clear understanding of your cash needs and your business's cash cycle is critical to any success.

A cash flow forecast projects operating cash inflow and outflow. As a tool, it allows business owners to determine if there is enough cash generated from operations to meet ongoing obligations. Used properly, it will alert management if and when the business is in need of additional cash infusions.

The surprise factor is something every management team wants to avoid, especially when it comes to liquidity. Realizing one day that your company is about to run out of cash creates a significant challenge.

Business cycles -- and the related timing of cash inflow/outflow -- can and do differ by business and industry. As such, the key to managing cash shortfalls is recognizing the problem as soon as it becomes apparent. Nobody likes surprises, especially if your lending source is a financial institution. Relationships with your bank, or even critical vendors, during cash shortage periods can become strained. The more time your business has to arrange additional financing, the more likely you'll be able to negotiate more favorable arrangements.

Because the actual cash receipts of a business do not necessarily coincide with revenue recognition or profit recognition, a business can experience cash shortages while, at the same time, be showing ongoing accounting profits. Converting sales into cash and making vendor payments and payroll before cash is received can be a delicate balancing act for businesses that face periods of cash shortfalls.

And while not all of these situations have the potential of being business-killers, if a pattern of continually needing cash infusions develops, it can be a warning sign that you need to take alternative measures to resolve the ongoing problems.

When determining your cash flow forecast, ground the assumptions in reality and document them. It is advisable, although not always practical, that the person preparing the forecast be familiar with the operations of the business, including the timing of capital expenditures. Additionally, a critical review should be performed by a second person who has knowledge of the company's business cycle and other factors unique to the company.

There are numerous software programs available to assist in your cash flow forecasts. And once your initial model is built, you can simply build on it for the future. Once the model is constructed, actual results should be compared to the projected amounts.

Variances will exist, and it is incumbent upon management to understand the reasons for them. Not all variations are negative, but it is important to determine if the underlying assumptions need to be modified as your business environment changes.

Some common pitfalls to avoid in your preparations include:

* Excessive optimism as it relates to the top line

* Understated expenses

* Lack of understanding of the timing issues of inflow and outflow

* Failure to consider capital expenditures and debt repayment requirements

* No margin for error

Many companies will prepare a best-case and worst-case scenario of the cash flow projections. This type of forward planning will not go unrewarded, as the company will be in a much stronger position to react to the changing environment.

The lack of liquidity or timely cash flow can result in the business failing regardless of the company's reported profits or losses. The fundamentals are the same in the preparation and use of cash flow forecasting regardless of a company's size.

Obviously, the larger the organization, the more complex the process is likely to be. However, every company can use the forecast in the same way. By implementing the proper disciplines and using cash flow projections as a planning tool, your business will be in a better position to assess and react to the changing business climate and needs of your company.

Sheldon Zimmerman (szimmerman@tbcpa.com) is a principal with Tauber & Balser PC in the Forensic Accounting & Litigation Services Group. With more than 30 years of professional experience, he advises companies on matters relating to mergers and acquisitions, due diligence reviews, accounting irregularities and bankruptcy matters. Reach him at (404) 814-4958.