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Private Equity Operational Due Diligence: Tools to Evaluate Liquidity, Valuation, and Documentation by Jason A. Scharfman

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CHAPTER 7

Financial Statement Due Diligence

Investors are becoming increasingly aware of the importance of document reviews during the private equity operational due diligence process. One of the most important sets of documents that investors should collect, analyze, and monitor are a private equity fund's audited financial statements. Audited financial statements provide a historical snapshot into the financial life of a private equity fund and can serve as a valuable source of information during the due diligence process. Before investing with any private equity fund manager, investors should take steps to analyze and understand the information contained in these documents. To fully capitalize on the information learned during a review of a private equity fund's audited financials, these reviews should be incorporated into the larger operational due diligence process.

Financial statement analysis is a useful tool that investors have in their operational due diligence arsenal to detect and evaluate a variety of operational risk factors that may be present at a private equity firm and fund. Before delving into a discussion of these techniques, it is first useful to gain an understanding of what is contained in a fund's audited financial statements. We will begin this discussion by considering the role of the group preparing them—the auditors. Auditors or audit firms are engaged by the management of a private equity fund to provide an accounting of the fund. Auditors conduct their ...

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