Navigating the minefield of M&A risks in the accounting sector

Due diligence in mergers and acquisitions (M&A) is a crucial process, essential for uncovering the financial, operational, and legal facets of a target company. Accountants play a pivotal role in this process, with their expertise directly influencing the outcome of an M&A deal.

There is a significant amount of preparation, documentation and due diligence that goes into the M&A process. At the forefront of this will be the report and accounts; companies contemplating a potential purchase will want to know exactly how healthy the financial position of their future partner or target is.

This initial overview will help establish whether the merger or acquisition is worthwhile, financially secure and, ultimately, a productive move.

According to KPMG, 83% of M&A deals fail to enhance shareholder returns, often linked to shortcomings in due diligence. Given the substantial global M&A volumes, which reached $4.4 trillion in 2021 as per the Institute for Mergers, Acquisitions, and Alliances (IMAA), the responsibilities of accountants in these transactions are more critical than ever.

The need for rigorous analysis extends beyond financial assessments, encompassing cultural, operational, and market evaluations. From the acquirer’s point of view, the M&A accountant effectively acts as financial translator, interpreting and explaining the accounts information of a target company to help them understand the financial position of their potential acquisition.

Historical cases, such as Hewlett-Packard’s acquisition of Autonomy, highlight the repercussions of inadequate due diligence and the importance of a comprehensive approach.

Understanding due diligence

due diligence is the meticulous process of evaluating a target company’s financial health, legal standings, operational efficiency, and strategic fit. This comprehensive assessment is pivotal in mitigating risks, uncovering value, and informing negotiation strategies.

For accountants, the due diligence process is a rigorous examination of financial records and compliance practices. It involves a deep dive into balance sheets, income statements, cash flow reports, tax compliance records, and more. Accountants play a crucial role in identifying potential financial liabilities, evaluating asset valuations, and ensuring the accuracy of financial disclosures.

The scope of due diligence extends beyond financial scrutiny. Legal due diligence encompasses the review of contracts, litigation risks, and legal compliance. Operational due diligence evaluates the target company’s business model, supply chain efficiency, and technology systems. Cultural due diligence assesses the alignment of corporate cultures and the impact on post-merger integration.

However, accountants often face challenges such as limited access to complete information, tight due diligence timelines, and the complexity of interpreting financial data across different jurisdictions and regulatory landscapes.

The impact of due diligence on the success of M&A transactions is significant. Thorough due diligence can reveal hidden risks, prevent costly mistakes, and contribute to informed decision-making, ultimately influencing the overall success and value realization of an M&A deal.

Common M&A pitfalls

As accountants delve into the due diligence process, awareness of potential pitfalls is crucial. While financial analysis forms the bedrock of due diligence, there are several areas where even seasoned professionals can stumble.

Incomplete Financial Analysis: The Autonomy and Hewlett-Packard debacle, where HP incurred an $8.8 billion write-down, is a stark reminder of the repercussions of incomplete financial analysis. Autonomy’s alleged accounting improprieties, undetected in due diligence, exemplify the need for meticulous financial scrutiny.

Overlooking Operational and Cultural Aspects: Deloitte’s insights into M&A underscore the risks of ignoring cultural alignment. Ineffective cultural integration can derail even the most financially sound mergers, leading to conflict, reduced efficiency, and employee dissatisfaction.

Legal and Compliance Oversights: The Verizon-Yahoo deal, which saw a $350 million reduction in valuation post-revelation of a data breach, highlights the critical importance of legal and compliance due diligence. This oversight demonstrates how unforeseen legal issues can significantly impact the final deal terms.

Financial due diligence

A structured approach is crucial for aligning the understanding of buyers and stakeholders and minimising any misunderstandings during the transaction.

It is through financial due diligence that the financial health of a business is thoroughly examined, including its historical and current financial performance. This assessment is essential in determining whether the transaction will be financially advantageous for the buyer.

Besides, as part of the financial due diligence process, the buyer’s team reviews the financial statements of the seller, which provide a summary of the accounting results for a specific time, including a fiscal or calendar year.

The main objective of financial due diligence is to establish future forecasts while taking into account any potential risks. A key aspect of financial due diligence involves scrutinizing financial statements, accounting policies, assets, debts, tax liabilities, cash flow, and projections to verify their accuracy and truthfulness.

A checklist for financial due diligence include:

• Audited financial statements, such as the cash flow statement, balance sheet, income statement, and footnotes, covering the past three years. These should be accompanied by an auditor’s report and quarterly and annual statements.
• Unaudited financial statements.
• Auditor’s correspondence for the past five years, particularly letters regarding the target’s accounting controls, this includes all Management Representation correspondences.
• An accounts payable schedule, particularly a schedule for any overdue or unpaid accounts that may affect the company’s profitability.
• A schedule of accounts receivable.
• The general ledger.
• Tax Information such as foreign, state, federal and local tax returns; excise tax filings; tax settlement documents for the past three years; and a schedule of undisclosed tax liabilities.
• Projections, which should include revenue by product type, customer, and channel, as well as all financial statements for instance, the balance sheet, cash flow statement, and cash on hand.
• An asset register including a copy of an up-to-date physical inventory of assets and equipment.
• Schedule of outstanding debt.