Free case study · Financial Due Diligence
ABC Company
School supplies distribution · Canada · FY22–FY24
Deal Summary
Our client is acquiring 100% of the shares of ABC Company, Inc. (the “Company”, “ABC” or “Target”) which sells and distributes school supplies throughout Canada. They have approached ANZ to complete financial and tax due diligence for the Historical Period (defined collectively as FY22, FY23, and FY24).
The LOI says that the purchase will be four times average normalized EBITDA for FY22 through FY24 with the initial offer valuing the Company at $22.5M. The transaction is on a cash and debt free basis. Normalized working capital target will be determined by ANZ during due diligence.
LOI
4× average normalized EBITDA
The manager on the file has asked you to prepare the normalized EBITDA and working capital schedules in the almanac along with a write up of these sections in addition to any other transaction issues or risks identified
Background
The Company is owned and operated by Mr. Jones. Mr. Jones is actively involved in the day-to-day operations of the business. His son, Mike Jones, also works on a full-time basis at the Company. The following is a summary P&L for FY22, FY23 and FY24:
Income statement
Summary P&L · FY22 – FY24
| $'000 | FY22 | FY23 | FY24 |
|---|---|---|---|
| Net sales | 21,564 | 23,204 | 23,935 |
| Cost of goods sold | 13,423 | 14,142 | 15,140 |
| Gross profit | 8,141 | 9,062 | 8,795 |
| Gross margin | 38% | 39% | 37% |
| Selling | 2,234 | 2,431 | 2,296 |
| General and administrative | 3,088 | 3,285 | 3,167 |
| Depreciation | 190 | 196 | 188 |
| Total operating expenses | 5,512 | 5,912 | 5,651 |
| Income from operations | 2,629 | 3,150 | 3,144 |
| Interest expense | (25) | (10) | (14) |
| Net income | 1,879 | 2,290 | 2,305 |
Management Add-Backs
The management team has identified the following addbacks be included for consideration in calculating the normalized EBITDA of ABC. After review of the underlying support, your team and the Partner on the engagement, are comfortable with the adjustments identified by management but they need to be documented and calculated for consideration in the EBITDA analysis.
Add-backOwner’s compensation
The owner-manager, Mr. Jones, consulted with his accountant and identified certain nonrecurring expenses during the Historical Period. As such, Mr. Jones and his accountant proposed to add-back his compensation during the Historical Period as he will not continue with the Company post-close. Mr. Jones’ compensation (fully-loaded, including fringe benefits) was $1,050, $900 and $950 in FY22, FY23, and FY24, respectively. The market rate salary for Mr. Jones is approximately $350.
Add-backOwner’s son compensation
Mr. Jones’ son, Mike, works as Mr. Jones’ executive assistant and manager of the administrative assistants in the Company. Mike works full-time and his annual compensation, per the accounting records, was $190, $200 and $225 in FY22, FY23, and FY24, respectively. Mike will not continue with the Company after the transaction takes place. The market rate salary for Mike is approximately $75. Mr. Jones said this should be considered as an EBITDA add back.
Add-backAircraft
Mr. Jones is a licensed pilot and has a small aircraft. The Company pays for all aircraft related expenses. The total annual aircraft expenses were $500, $600 and $600 in FY22, FY23, and FY24, respectively. Mr. Jones said this should be considered as an EBITDA add back.
The partner on the transaction is also a licensed pilot and Mr. Jones took him on his aircraft to go for lunch at Wolf In The Fog in Tofino. During their lunch, Mr. Jones said the aircraft was excluded from the transaction and as such, the annual expenses should be added-back to EBITDA. Mr. Jones estimates approximately 60% of the aircraft usage was for non-business purposes during the Historical Period. Mr. Jones was unsure how the above would factor in to EBITDA.
Add-backGolf Club Membership
Mr. Jones has been a member of a local private golf club where he interacts with many business associates. The Company pays for Mr. Jones’ annual food and alcohol tabs, which are non-business related, and have amounted to $42, $24 and $44 in FY22, F23, and FY24, respectively. Mr. Jones said this should be considered as an EBITDA add back.
Diligence Work Performed to Date
The following is a summary of due diligence work that has been performed to date by other team members:
Audit files
Audit files
Your discussions with the audit partner on the account reveal that the company had no internal control system, uses QuickBooks as its accounting software and that Mr. Jones and his son are very involved in the day-to-day operations of the Company.
The audit was performed following a substantive based approach and an unqualified opinion was issued in March 2025. The audit materiality was $140 in FY24. The auditors proposed four adjustments of which two were recorded by the Company. The remaining two audit adjustments were waived as they were not material to the financial statements as a whole. These waived adjustments related to:
UAJE 3: Sales of $30 were recorded for an order received in FY24 that was shipped on January 1, 2025. The inventory related to this sale was counted and included in the December 31, 2024, inventory count.
UAJE 4: The second adjustment for $35 related to a payroll accrual for the number of days from the last pay day to year end. The auditors proposed a similar adjustment of $21 in FY23 which was not recorded by management. The payroll accrual at the end of FY22 was correctly recorded.
Additional support to UAJE 4 showed that the payroll accrual at the end of each during the last fiscal year should have been as follows:
UAJE 4 — Supporting schedule
Monthly payroll accrual ($'000)
| Period | Jan-24 | Feb-24 | Mar-24 | Apr-24 | May-24 | Jun-24 | Jul-24 | Aug-24 | Sep-24 | Oct-24 | Nov-24 | Dec-24 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Accrual | 12 | 35 | — | 25 | 15 | 10 | 40 | 32 | 24 | 17 | 5 | 35 |
Analysis of Accounting Records and Discussions with Management
Accounts receivable write-off
During the Historical Period, the Company had minimal bad debt expenses except in FY23. The Company had a dispute with a customer and the customer refused to pay, on the basis that the Company’s product did not meet minimum quality standards that had been agreed to in the customer contract prior to the sale. There have since been no further sales with this customer. In FY23, the Company wrote off (i.e., Dr. Bad debt expense, Cr A/R) the outstanding A/R of $150 and sent the account to collection. Mr. Jones told the diligence Manager: “Christmas came early this year; the collection agency collected the full amount plus their fees and we received the full $150 in early December 2024”. Based on the conversation with the controller, the diligence Manager found out that the amount collected did not impact the FY24 net income as the amount was recorded as a Dr. to cash and Cr. to allowance for doubtful accounts.$
Christmas came early this year; the collection agency collected the full amount plus their fees and we received the full $150 in early December 2024.
Seasonality of business
sales tend to peak during the school year, particularly August and September, and are slow during the months of June and July.
Inventory obsolescence
the Company records its inventory reserve at year end and does not adjust on a monthly basis. Based on analysis performed, ANZ determined that the Company underestimated its inventory obsolescence reserve, as follows:
Inventory obsolescence
Reported vs. DD adjusted
| Inventory obsolescence ($'000) | Dec-21 | Dec-22 | Dec-23 | Dec-24 |
|---|---|---|---|---|
| Inventory obsolescence reserve (reported) | 100 | 125 | 115 | 200 |
| % of inventory | 3.4% | 4.2% | 4.0% | 6.8% |
| Impact on P&L (reported) | — | (25) | 10 | (85) |
| Inventory obsolescence reserve (DD adjusted) | 125 | 165 | 145 | 250 |
| % of inventory | 4.2% | 5.5% | 5.1% | 8.5% |
| Reported inventory before allowance | 2,945 | 3,001 | 2,851 | 2,945 |
It was further noted that the reserve, as a percentage of gross reported inventory, as calculated by ANZ at December 31, 2024 would be representative of the appropriate reserve to apply to the gross inventory value reported throughout the entire fiscal year for FY24.
Other diligence observations
During due diligence it was discovered that the Company had received a large number of shipments from its key foreign supplier totaling $125. The inventory received was included in the year-end inventory although the related invoices were not received or accrued in the purchases account (i.e., the inventory itself was included in the month-end count and ending inventory valuation even though the invoices had not been accrued (credited) and the purchases account had not been debited). The Company’s cost of goods sold was calculated by taking the inventory purchases account plus opening inventory less closing inventory. It was further noted that this supplier comprised 80% of the Company’s purchases historically.
Interest expense
Upon further review of the interest expense line item you noted included therein was $6, $4 and $5 of non-interest-bearing general bank charges.
Balance Sheet
Monthly snapshots — FY24
Balance sheet
Monthly balances · FY24
| Balance sheet ($'000) | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Cash | 124 | 145 | 153 | 278 | 225 | 176 | 212 | 227 | 238 | 321 | 174 | 138 |
| Accounts receivable, net of AFDA | 650 | 751 | 689 | 632 | 679 | 578 | 754 | 1,457 | 1,845 | 699 | 813 | 814 |
| Inventories, net of allowance | 3,500 | 3,221 | 2,789 | 2,999 | 3,001 | 3,002 | 3,001 | 4,521 | 4,213 | 3,001 | 2,954 | 2,745 |
| Prepaid expenses | 5 | 0 | 6 | 5 | 47 | 8 | 9 | 6 | 0 | 42 | 48 | 100 |
| Due from related parties | 450 | 455 | 460 | 465 | 470 | 475 | 480 | 485 | 490 | 495 | 500 | 505 |
| Income tax receivable | 50 | 55 | 45 | 78 | 80 | 50 | 70 | 75 | 60 | 50 | 70 | 60 |
| Total current assets | 4,824 | 4,692 | 4,183 | 4,541 | 4,515 | 4,323 | 4,565 | 6,843 | 6,944 | 4,676 | 4,614 | 4,319 |
| Property, plant and equipment | 1,225 | 1,220 | 1,215 | 1,210 | 1,205 | 1,200 | 1,195 | 1,190 | 1,185 | 1,180 | 1,175 | 1,170 |
| Total assets | 6,049 | 5,912 | 5,398 | 5,751 | 5,720 | 5,523 | 5,760 | 8,033 | 8,129 | 5,856 | 5,789 | 5,489 |
| Accounts payable and accrued liabilities | 504 | 524 | 578 | 652 | 612 | 714 | 498 | 453 | 457 | 522 | 547 | 559 |
| Customer deposits | 124 | 145 | 165 | 214 | 197 | 147 | 98 | 224 | 238 | 222 | 278 | 298 |
| Current portion of capital lease obligations | 20 | 20 | 20 | 20 | 20 | 20 | 20 | 20 | 20 | 20 | 20 | 20 |
| Current portion of long-term debt | 250 | 250 | 250 | 250 | 250 | 250 | 250 | 250 | 250 | 250 | 250 | 250 |
| Total current liabilities | 898 | 939 | 1,013 | 1,136 | 1,079 | 1,131 | 866 | 947 | 965 | 1,014 | 1,095 | 1,127 |
| Long-term capital lease obligations | 100 | 98 | 97 | 95 | 93 | 92 | 90 | 88 | 87 | 85 | 83 | 82 |
| Long-term debt | 1,000 | 979 | 958 | 938 | 917 | 896 | 875 | 854 | 833 | 813 | 792 | 771 |
| Total liabilities | 1,998 | 2,017 | 2,068 | 2,169 | 2,089 | 2,119 | 1,831 | 1,890 | 1,885 | 1,912 | 1,970 | 1,980 |
| Shareholder’s equity | 4,051 | 3,896 | 3,330 | 3,583 | 3,631 | 3,405 | 3,929 | 6,144 | 6,244 | 3,945 | 3,819 | 3,510 |
| Total liabilities and equity | 6,049 | 5,912 | 5,398 | 5,751 | 5,720 | 5,523 | 5,760 | 8,033 | 8,129 | 5,856 | 5,789 | 5,489 |
End of Case
Supporting schedules and exhibits are included in excel response document.
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ABC Company · School supplies distribution · Canada