Due diligence masterclass: Finance

Financial due diligence is the cornerstone of our investment process and the foundation for a strong investment application.

As part of this, we review both the past and current financial performance of applicant organisations (and the reflection of this in its available assets) and the policies and processes for financial review and control at management and governance level. Below we break down some of the key information we look for in the course of financial due diligence.

Funding need & repayment plans – sources and uses of cash

First things first – we need to understand what your organisation needs funding for, specifically, and how you intend to repay the investment. There needs to be a really clear idea here – well researched and thought through, making clear its assumptions, opportunities and risks. We are happy to give an informal steer on semi-developed proposals, but these are not going to be investment ready and would require further development, and possibly additional support, before taking on repayable finance. A documented business plan is a good way of showing that your organisation has thought about all the key issues, but it is not the only way – if you are a structured and concise verbal communicator, we can get all the information we need through a conversation.  We will also need to see where you are getting any other funding for the project from, and how much of this is borrowed and has to be paid back.

Historical annual accounts

We will also want to review your organisation’s financial performance over the last few years – typically the last three, but also any periods/projects particularly relevant to the funding requirement – to see overall trends in income, expenditure and sustainability.

Management accounts

Good management accounts should, at the very least, include the year-to-date actual income and expenditure figures compared with the budget and a column listing variances. In best financial management practice, these numbers are compared to actual figures from the previous year and include narrative explaining significant variances, and any assumptions behind the forecasts.

Management accounts vary in content and presentation across different organisations. Some might incorporate cashflow statements and balance sheets as well as a narrative update on the period. Others might be simple income & expenditure breakdowns. One thing we will need to be satisfied with is whether they convey the information they need to, and are clear and accessible enough to their relevant audiences. 

Balance sheet

A great addition to management accounts, the balance sheet tells us about the sum of an organisation’s assets  as well as the liabilities it owes. This helps us get a sense of both how much cash there is currently to manage day-to-day expenses, and how much could be realised quickly if it were necessary (liquidity). As investors, we have to ask ourselves the question – would the addition of our loan, another liability, be prudent given the applicant organisation’s other existing obligations, and how might the balancing item (the proceeds of the loan, or what they are used for) develop over time?

For a charity, the balance sheet also tells us how much of its reserves are restricted, and therefore off-limits for the purposes of both paying off our investment and meeting core (unrestricted) cost obligations.

Forward-looking cashflow forecast

Cash, as they say, is king. It does not matter much if there is guaranteed funding 6 months in the future if an organisation does not have cash to pay salaries and other bills in the here and now. In the course of financial due diligence, we will want to make sure applicant organisations have sufficient funds to manage incoming and outgoing cashflows. A way to make cashflows a better tool for financial management is to use them to show both future projections and historical, i.e. actual figures. This will tell us what actually happened in past forecasts compared to prior expectations and will help you understand where expectations were not confirmed, so you can look into why this was the case. 

Other items

Altogether, this is not an exhaustive list. Depending on the circumstances, we may need additional information.

For instance – for an organisation dependent on winning chunky pieces of funding from grants, private donations or corporate giving that require development of more long-term relationships with funders and supporters, we would expect to see a business development or fundraising pipeline (typically in the form of a spreadsheet) that outlines targeted funders, the amounts applied for, key decision milestones and the likelihood of success.  

For an organisation or an investment proposal reliant on a more commercial trading model, we will want to see the organisational or venture’s financial model in Excel. Models do not necessarily have to use complicated spreadsheets or multiple spreadsheets that link to each other although we expect this would correspond to the nature, risk involved and complexity of the proposed venture. What we are looking for is a deep understanding of the variables and assumptions in the business and what their impact on the model is. We will do our own financial modelling to this end; undertaking a financial modelling exercise yourself can be a good way to develop that understanding.  

Naturally, applicants’ financial performance will be taken into account alongside their social impact, including how the two elements interact with each other and affect other core funding relationships as well as the capacity of their teams to deliver.