Due diligence of assets is crucial for startups to identify potential risks, liabilities or hidden costs associated with them. We evaluate how assets operate and gather comprehensive insights to assist in making well-informed decisions about acquiring or investing in a Company. Here, we focus on due diligence of assets and its importance for investors, founders, and stakeholders. Let’s delve into how to conduct a due diligence of assets:
Tangible Assets
Fixed Asset Register: Verify whether Fixed Assets Register is being maintained and verify the amounts recorded in the books of accounts along with review of sample invoices for purchases.
Recognition And Classification: Review whether recognition criteria as per AS 10 and Ind AS 16, as applicable, have been met for the tangible assets and they have been classified correctly in the books of accounts.
Capitalization Of Cost: Check whether the amount recorded in the books of accounts only includes purchase price and costs directly attributable to bringing the tangible asset to the location and conditions necessary to make it capable of operating in the manner intended by management.
Depreciation: Understand the basis for determining useful life of the tangible asset, and verify the depreciation method, residual value, and the underlying calculation for the same.
Physical Verification: In compliance with regulatory requirements, conduct physical verification of the tangible assets on a periodic basis and ensure a log and approval mechanism is being followed to document the same.
Treatment of Input Tax Credit (ITC): Verify correct recording of GST ITC on purchase of tangible assets, including assessing whether the same shall be eligible or blocked credit, and map with the GST returns filed.
Asset Tagging: Verify whether unique identification numbers (asset tags) have been allotted to each of the tangible assets in order to keep track as well as prevent loss or theft.
Intangible Assets
Recognition Of Intangible Assets: Review whether recognition criteria as per AS 26 and Ind AS38, as applicable, have been met for the intangible assets and they have been classified correctly in the books of accounts.
Amortization: Amortization of an intangible asset commences when the same is available for use. Verify the underlying workings and ensure amortization of intangible assets has been correctly recorded in the books of accounts.
Domain Name And Trademarks: Quite often, domain names and trademarks are registered in the founder’s name rather than the company’s name, in the interest of time or by way of oversight. Check to ensure that Domain and Trademarks have been correctly registered in the name of the company.
Internally Generated Intangible Assets: Ensure that internally generated intangible assets such as internal brands, mastheads and publishing titles have not been recorded as assets in the books of accounts.
Confidentiality in Employment Agreements: Review employment agreements, especially of employees working in product / tech development, and ensure “Confidentiality” as well as “Invention Assignment” clauses are captured to avoid any future litigation regarding the product/ tech being developed.
Non-Current Investments
Cost Of Carrying: As per the applicable standard, non-current investments are usually carried at cost. Verify whether the non-current investments have been recorded at costs and in case of deviations evaluate whether the same is due to a permanent or temporary changes for assessing whether the impact, if any, has been properly provided for in the books of accounts.
Documentary Evidence of Title: Verify ownership documents for all investments and verify whether requisite compliance of the provisions of the Income Tax Act, 1961 and Foreign Exchange Management Act, as applicable, has been done to ensure clean title.
Investment of Idle Funds: Check whether proper management of idle funds has been done, by way of investing excess funds to generate returns and reduce financial risks.
Investment Valuation: Assess the valuation methodologies and assumptions for non-current investments appearing as assets in the books of accounts. Evaluate if the valuations are in line with industry standards as well as accounting standards.
Report And Disclosures: Verify whether proper disclosures have been provided regarding non-current investments in the financial statements.
Loans And Advances
Related Party Transactions: Understand the reason for extending loans and advances to related parties, and ensure the terms are fair and not prejudicial to the interest of the company.
Review Of Loan Agreements: Review loan agreements and terms to understand the rights and obligations of the parties, paying close attention to interest rates, repayment schedules and default provisions.
Accounting And Repayment: Verify whether accounting for loans and advances has been done correctly in the books of accounts, including verifying calculation of interest, and mapping collections in the bank statements.
Compliance With Statutory Requirements: Understand whether loans and advances have been extended in compliance with and within the limits prescribed by Section 186 of the Companies Act, 2013. Further, also ensure that the register for loans and advances as per regulatory requirements are being appropriately maintained.
Inventories
Stock Insurance: Verify stock insurance coverage for all business locations storing inventory,protecting against damage, theft, or loss.
Inventory Turnover Ratio: Measure how effectively inventory is managed. A high ratio
indicates efficient sales; a low ratio suggests excess stock.
Valuation Of Inventories: Proper inventory valuation (FIFO, WAC, LIFO) impacts the cost of goods sold and overall inventory value. Verify the basis of valuation of inventories and compare with the best practices being followed.
Physical Verification: Regular surprise checks to compare physical counts with recorded amounts, identifying discrepancies. By using various methodologies, such as Pareto analysis (ABC analysis), Stock Keeping Units (SKUs) samples can be identified for verification.
Reconciliation Of Inventories: Verify inventory records as per books of accounts with actual physical stock and understand the reasons for differences.
Damaged Or Obsolete Goods: Any damaged or obsolete stock identified should not appear as an asset in the books of accounts. Regular reviews should be conducted to write down spoiled items, ensuring realistic inventory valuation.
Inventory Trail: Understand the inventory flow and ensure accurate tracking, from acquisition to sale, also checking for compliance with regulations like E-invoicing and E-way bills.
Supply Chain Management: Evaluate whether there is effective management to maintain optimal inventory levels, preventing shortages or overstock.
Accounts Receivables
Related Party Transactions: Inquire and identify related parties, and transactions conducted with them. Verify the terms of the arrangement to ensure fair terms and transactions at arm’s length price.
Balance Confirmation: Verify long-standing receivables for accuracy by way of external confirmations from customers.
Disclosure Of Long Overdue Receivables: Transparent reporting of overdue receivables, including provisions for doubtful recovery.
Receivable Turnover Ratio: Measures efficiency in collecting receivables, indicating credit management effectiveness. Verify the receivable turnover ratio to understand how efficient the company is compared to the industry in managing customer credit.
Debtors With Credit Balance: Inquire into the reasons for debtors with credit balances and verify whether any sales / outward supplies have not been recorded in the books of accounts. Further, evaluate the potential GST implications and tax liabilities.
Ageing Schedule: Identify long-outstanding debtors beyond the normal credit period, and understand the reasons for delay in collections.
Bad Debts: Ensure provisions for long-standing debtors are adequate and check whether irrecoverable amounts have been written off.
Cash and Cash Equivalents
Balance Confirmation: Obtain balance confirmations for the banks to verify amounts appearing as bank balances and fixed deposits in the books of accounts.
Physical Cash Verification: Conduct surprise cash verification and obtain sign-off to ensure cash is being managed properly.
Compliance with Income Tax: As per Section 40A(3) of the Income Tax Act, 1961 cash
payments to a single person in a single day should not exceed INR 10,000. Understand the reasons for not making payments through banking channels and ensure cash payments are monitored to avoid any dis-allowances.
Compliance with Companies Act: As per Section 42(6) of the Companies Act, 2013, verify whether a separate bank account is being maintained for receipt of share application money. This account should be reserved for allotment adjustments and refunds in case of any non-allotments.
Bank Reconciliation: Obtain bank reconciliation statements and ensure balances as per bank match with amounts recorded in the books of accounts.
Conclusion
Thorough due diligence on assets is what Indian startups need to make sure of transparency, thereby minimizing risks and attracting investors. Informed decisions based on a due diligence exercise will foster growth and propel the startup to success.
Take the first step towards a brighter financial future. Partner with Constellation Blu for comprehensive due diligence and unlock your startup’s full potential. Reach out to us today!
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