Introduction
The due diligence process entails the actions a financial institution carries out to evaluate the potency of an investment institution based on the risks and benefits pertaining to a potential investment decision. In most international finance institutions such as the World Bank, a due diligence report plays vital roles in evaluating the probable risks and benefits accruable to a financial investment, thus offering the finance institution an in depth understanding to the investing partners’ capabilities (Kaufman 67). The due diligence process with efficacy uses structured methodology and trained personnel to review and update key components of the financial transaction in question, and develop a plan for the implementation of the recommendations of the final report. As the main components of a due diligence report, a management plan that stipulates the actions necessary for monitoring and supervising the probable credit extension helps the financing institution develop working plans for the investment.
Components
Under the international financial institutions programs, due diligence report covers five major components of company profile.
Corporate image
In this component, due diligence report uncover the public image of the investing company in question. Contracted due diligence personnel assess the number of pending lawsuits against the company, negative media publicity, and transparency issues pertaining to the management structures in the company. In evaluating the lawsuits, due diligence seeks to understand the driving force behind the suit, and assess the culpability of the investing institution. Even though lawsuits are not direct ways of withdrawing funding, they help the financing institution develop an understanding of the legal problems existing within the investing party (Kaufman 68). Negative public image derails a business’s success. This implies that understanding the public picture within the domain of consumers helps the financing institution develop goals and objectives based on the existing consumer convictions (Green and Carroll 18).
Social responsibility
As Green and Caroll (19) argue, social responsibility represents an important segment of business success. With an adequate corporate social responsibility policy, a business entity engages in non-profit community service activities, thus striving to alleviate some of the social ills rampant in the society. Some of the social responsibility activities in the major business entities entail sponsorship deals for sporting persons, teams, and event, organization free health care campaigns, and offering scholarship opportunities to the bright and needy members of the society. In this manner, business entities do not only offer non-profitable services to the community, but also consolidate the consumer base through advertisement. For the financing institution, planning an investment activity within a given business entity and understanding the social responsibility activities already in place help in developing adequate budgeting to ensure continuity and improvement of such activities (Green and Carroll 21).
Under social responsibility lies the assessment of labor standards and remuneration packages for the employees. For the financing institution, understanding this tool ensures proper analysis of the salary and wage structures of the employees. Evaluating these statistics in relation to the international standards and local laws helps the financing institution evaluate the levels of employee motivation and conditions before embarking on an investment deal. Likewise, understanding the health and safety conditions at a workplace enables the financing institution to develop an understanding of the level of care and appreciate the proposed safety standards that the investment institution holds against the employees (Green and Carroll 26). In a world where occupational, health and safety standards play vital roles in company success, financing institutions must understand the health and safety policies pertaining to employee protective equipment at the workplace. This helps in evaluating the risk levels of costs associated with employee injuries and accidents. Under the labor and employment standards, due diligence process helps the financing agency to evaluate the employment culture within the investing partner. Issues such as child labor, affirmative action in employment, inclusion of the priority to the marginalized and vulnerable members of the society into employment opportunities, and inclusion of employee unions in the management structure help the financing institution in evaluating the corporate level of the investing partner. In essence, a company’s code of ethics and professionalism remain vital facets of the social responsibility. Apart from developing a work ethics and ensuring transparency and accountability, ethics policy stipulates disciplinary measures accruable to defaulting employees. In the due diligence process, understanding the ethics policy helps the financing institution appreciate the investment culture within the investing institution (Green and Carroll 31). Besides, ethics policy enables the financing institution to create a checklist for intolerable activities within the investment deal.
Environmental accountability
Environmental accountability assessment during due diligence ascertains the investing partner’s ability to assess and adequately address future environmental and safety impacts arising from the provision of goods and services. Taking into account the life cycle analysis of the product and services, developing environmental impacts check systems enables business entities to design ameliorative measures for the foreseen impacts. Due diligence seeks to understand the ability of the investing agency to assess and communicate to consumers and employees on the probable environmental, health, and safety impacts and the probable corrective measures in place. Understanding these factors helps financing institutions in evaluating the environmental sustainability culture in the proposed partner (Green and Carroll 25). However, corrective measures set out in environmental, health and safety plans may harbor loopholes. In case of failure of a system used in the production of goods and services, environmental, health, safety, and occupational costs arise. Carrying out due diligence enables the financing agency to assess the viability of the contingency plans put in place for such accidental activities. Environmental accountability helps the financing agency to evaluate corporate environmental performance of the proposed investment partner. During this process, the evaluating agency takes into account the programs and strategies the investing agency has in place to encourage the use of clean development mechanisms and technologies in the production of goods and services. Assessing production units ensures adequate understanding of an industry’s best practices in relation to the emerging environmental issues such as global warming and climate change. Assessment of energy use levels in the production systems provides an in depth understanding of the goals and aspirations of the investing institution towards environmental sustainability. Likewise, product use, reuse, and recycling help ascertain the environmental culture within the proposed investment partner. Notably, assessing all these facets of environmental sustainability helps the investing agency develop the probable environmental costs (Green and Carroll 36).
Financial viability
In assessing financial soundness of the investing agency, due diligence assesses the ability of the investing institution to fulfill the commitments in a non-binding agreement to spearhead the investment. Using the annual rate of returns, financial statements, and annual investment reports, due diligence report helps the financing institution to understand the financial capabilities of the investing partner (Kaufman 69). Financial assessment enables the financing institution understand the investment record of accomplishment and business life of the proposed partner, hence helping in evaluating its viability and potency (Lai 12).
Policy assessment
Policy evaluation helps in assessing a company’s policy compatibility with the existing laws and regulations in the area of business. According to Lai (14), policy evaluation ensures that consistency in business practice between the investing agency and the financing partner. Due diligence ensures adequate elucidation of gaps existing in the business practice between the two entities before signing of the memorandum of understanding and commencement of business.
Timing and process of due diligence
Timing
Financing institutions carry out due diligence on potential resource partners, agency implementers, and contractors. Often aimed at ascertaining the compliance level of the partner, due diligence helps the financing institutions to assess and evaluate the probability of successful investment plan under a third party. The process often takes place at negotiation stages of an agreement and continues through to project decommissioning (Kaufman 71). In case an amendment is initiated into a project after contract agreement, the financing agency initiates a new due diligence reporting systems congruent with the amendment.
Process of due diligence
Planning
At the initial part of a due diligence process, planning ensures booking and recording of all the plans, persons, and resources necessary for the execution of the process. At the planning stage, the financing agency through their due diligence department develops a work plan in consultation with the investment partner to execute the process. It is at this stage that the due diligence team develops a set of structures and methodologies for assessing the compliance level of the investing agency (Camp 49).
Information collection
From the company websites, news articles, reports, and other publications, the due diligence team gathers information pertaining the product and services of the investing agency. Camp (51), in his analysis of investment feasibilities, claims that through metrics sustainability reports, financing agencies acquire information on the performance of the proposed investment partner. Collection of data from online sources fails to give adequate and concrete information, especially on the financial capabilities. Authentication of such information from the relevant authorities enables the due diligence team to evaluate such information before use.
Information analysis
From the list of questionnaires developed at the planning stage, the due diligence team evaluates the viability of the proposed investment partner in relation to the information gathered in the previous stage. In this stage, the due diligence team must develop a matrix for question analysis in order to ascertain the compliance level of the proposed partner (Camp 53).
Due diligence reporting
Reporting the findings of the due diligence process provides an ultimate decider for the partnership gaps identified, and the financing institution takes the decision on the proposed partnership. From the report, the financing institution assesses the costs and the benefits of the proposed partnership. If there are gaps in the components discussed above, the financing agency recommends corrective measures for compliance before entering into a contract (Camp 54). In other cases, the financing agency withdraws from the partnership if the gaps in place present high implementation costs. After entering into the contract, due diligence process continues through continuous monitoring, evaluation, and analysis of product and service to ensure compliance of the investing partner.
Importance of effective due diligence report
Effective due diligence report enable interested parties to understand the assets and their existing historical performance, especially on historical financial trends. Likewise, it necessitates the identification of the key risks and costs present in the investment deal. Such an assessment ensures coverage of the costs foreseen within the budget allocation of the proposed funding. In the identification of costs and risks, due diligence report offers opportunities for restructuring of partnership and development of alternatives such as price considerations, collateral requirements, and frequent reporting strategies (Kaufman 70). Through due diligence, the partners develop a mutual understanding of the critical policies and legal frameworks that govern the risks and costs associated with the partnership. These ensure proper elimination of legal gaps, hence improving the decision-making process. Besides, it provides a framework for addressing issues and concerns of the interested parties, ensuring that each party focuses on making sound and viable decision in the memorandum development (Scharfman 29). Even though due diligence lacks jurisdiction on corrupt and unethical activities outside the business management structures in the parties, it offers an opportunity for the parties to elucidate unusual transactions, discrepancies in the finance and accounting records, and other unethical activities in the business. Scharfman (31) notes that due diligence report reveals key indicators of fraud such as missing evidence on a case in question and activities beyond the normal business course.
Conclusion
Due diligence report seeks to give a comprehensive view of the probable profit levels of an investment partnership. Since it gives an in depth analysis of the existing situation in a given firm, due diligence offers the financing institution opportunity to understand the financial, legal, environmental, and social status of the proposed partner. As the world moves toward sustainability in business and development, financial institutions continue to focus on due diligence to ensure that the investing partners remain compliant to the emerging global trends in business practices.
Works Cited
Camp, Justin. Venture Capital Due Diligence: A Guide to Making Smart Investment Choices and Increasing Your Portfolio Returns. New York: Wiley, 2002. Print.
Green, Richard, and James Carroll. Investigating Entrepreneurial Opportunities: A Practical Guide for Due Diligence. Thousand Oaks, Calif.: SAGE Publications, 2000. Print.
Kaufman, Carol. “Shadow accounting: The evolving practice of exercising due diligence in fund reporting.” Journal of Financial Transformation 10.1 (2004): 67-71. Print.
Lai, Richard. Operations Forensics: Business Performance Analysis Using Operations Measures and Tools. Cambridge, Mass: MIT, 2013. Print.
Scharfman, Jason. Hedge Fund Operational Due Diligence: Understanding the Risks. Hoboken, N.J.: Wiley, 2009. Print.