How Due Diligence in Business Planning can help Avoid Costly Write-Offs
It really does not matter how much time, effort, and money you put into your business plan, if you do not do all of your homework, it all could come crumbling down very quickly. In the news recently, was just one more example of a company that failed to do their due diligence and suffered the consequences.
Caterpillar, one of the world’s most respected companies purchased a Chinese firm named ERA Mining Machinery Ltd and its subsidiary Siwei for $653.4 million. Unfortunately for them, they failed to research the transaction fully, and were forced to write off $580 million in goodwill.
For a company that is this sophisticated and thought to be exceptionally well managed to let a major blunder like this happen, is almost beyond belief. Especially when you take into account the reputation that some of China’s companies have when it comes to their accounting standards, and following GAAP to the letter.
A Sydney based fund manager for Bronte Capital named John Hempton, said that he shorted Caterpillar’s shares after conducting 20 minutes of research. The problem that he easily identified was that their receivables took 180 days to collect, which was twice the industry average.
Caterpillar became concerned when they discovered problems with Novembers physical inventory, when compared to what was recorded on the books.
If you are contemplating a merger or acquisition, there are certain basic steps that must be employed to complete your due diligence. Some of these are confirming the company’s cash and securities, reviewing the sales transactions ensuring they are being recorded properly, checking AR and doing ratio analysis, and the probably the most basic, to physically see, count, and value the assets of the company.
In accounting terms, goodwill is calculated by taking the purchase price paid for a company and subtracting the fair market value of its assets. In this instances, Caterpillar paid $653.4 million for the firm and had to write off $580 million in goodwill. That of course means, they only acquired $73.4 million in assets, which is just one more troubling and unexplainable problem with this transaction.
This is not the first time an American company has suffered a huge loss because of accounting irregularities performed by a Chinese company. John Paulson, who is a billionaire hedge fund manager invested in Sino Forest and was forced to take a massive write off when his company found out Sino Forest’s timber assets had been falsified.
In addition, dozens of Chinese companies that were once registered on U.S. stock exchanges, have been deregistered because of fraud found in their accounting records.
It really does not matter if you are just starting a business, already running a business, or contemplating purchasing an existing business, producing a well researched and conservative business plan will always give you a leg up on the competition. However, they are just one of a whole host of techniques that you need to employ to ensure that your business is successful as possible.
- Covid-19 Impact on US Private Capital Raising Activity in 2020 - May 27, 2021
- Healthcare 2021: Trends, M&A & Valuations - May 19, 2021
- 2021 Outlook on Media & Telecom M&A Transactions - May 12, 2021
