The third quarter of 2022 saw the M&A market decline globally due to economic uncertainty, market volatility, rising interest rates, inflation, and the ongoing Ukraine-Russia conflict. While private equity deal activity declined slightly compared to previous years, it still increased from the pre-COVID era. As companies prepare for a potential recession, they must take extra steps in due diligence to assess and vet potential acquisition targets.
The Role of Due Diligence Providers
Private equity firms rely on due diligence providers to accurately assess potential acquisition targets. In today’s economic climate, due diligence providers must go beyond standard reporting checklists and expand their assessments of key areas:
Cash Flows
A cash-flow analysis is no longer a nicety but a necessity in the current market. Due diligence providers should stress test a company’s ability to sustain losses and maintain sustainable liquidity and cash.
Conducting a Cash-Flow Analysis
- Evaluate sales by discounts, returns, and allowances: Assess how these factors affect a company’s cash flow.
- Analyze accounts receivable and payable: Determine the impact of changes in payment terms on cash flow.
- Review inventory management: Identify potential bottlenecks or inefficiencies that could strain cash flow.
Inventory Management
A well-managed inventory is crucial for maintaining cash flow and reducing costs. Due diligence providers should assess a company’s inventory management practices, including:
- Inventory levels and turnover rates
- Storage and shipping processes
- Supplier relationships and pricing
Reporting Systems
Outdated or disparate reporting systems can lead to mischaracterizations or misreporting of financial items. Due diligence providers should evaluate a company’s reporting systems, ensuring they are up-to-date, aligned, and streamlined.
Additional Considerations
- Foreign currency fluctuations: These have been affecting deals in recent months, resulting in abandoned transactions.
- Stress testing potential acquisition targets: This helps identify potential weaknesses or areas for improvement.
By implementing these due diligence considerations, private equity firms can strengthen deals and better protect all parties involved while ensuring financial readiness for M&A – regardless of economic conditions.
Conclusion
The current market demands a more thorough approach to due diligence. By assessing cash flows, inventory management, and reporting systems, due diligence providers can help private equity firms make informed investment decisions and mitigate potential risks. In the face of economic uncertainty, taking extra steps in due diligence is no longer a nicety but a necessity.
About the Author
Corey Massella is a partner at UHY LLP and managing director at UHY Advisors. With over 25 years of experience as an entrepreneur, tax and business adviser, and SEC accounting and audit specialist, Corey brings expertise to guide readers through the complexities of due diligence in M&A.
Recommended Reading
- "The Importance of Due Diligence in Mergers and Acquisitions"
- "How to Conduct a Thorough Due Diligence Process"
- "Best Practices for Managing Inventory and Cash Flow in a Post-Recession Economy"
