Buy Side & Sell Side Diligence

Income statement adjustment, plus run-rate estimate recommendations.

Metal recycling target with inconsistent accounting practices.

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  • Industry | Scrap Metal Recycling & Processing
  • Engagement | Limited scope quality of earnings review related potential acquisition.
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Client

Conglomeration of various industrial companies in the scrap metal recycling, zinc-based and aluminum-based products manufacturing, and reusable materials operations advisory spaces.

Target

Family-owned full-service scrap metal recycling company. The Company specialized in the processing of ferrous and non-ferrous metals, including copper, aluminum, steel, and lead, while also providing demolition processing and railcar dismantling services.

Situation

Target maintained a limited finance and accounting function, including the CFO supported by 2 finance personnel, with significant reliance on a third-party CPA firm for adjusting entries, tax preparation, and financial reporting. The CFO, new to the business within the last two years at the time of diligence, served as the main point of contact and was unable to provide answers to several detailed historical trending questions.

Target maintained a separate system for tracking inventory which relied on manual processes, including manual input to the GL. Material purchases were booked to COGS on the income statement—rather than inventory on the balance sheet—with quarterly adjustments to the inventory balance. These adjustments were based on estimates of material on hand made by experienced staff, rather than actual physical counts/weights. As the third-party CPA firm prepared the adjusting entries, Management was unable to fully explain the basis of the adjustments.

Target had multiple related entities, which presented challenges in arriving at a normalized level of business activity.

Solution

Increased adjusted EBITDA for capital expenditures recorded to the income statement should have been capitalized. Based on the rate of capital replenishment compared to the rate of capital depreciation, RedRidge presented a recommendation to the Client to consider Management’s estimate of run-rate CAPEX in the determination of the final purchase price.

Analyzed reported COGS and OpEx to determine which expenses represented the cost of goods sold versus period costs. Based on discussion with Management, RedRidge made necessary adjustments to the income statement to present historical gross margins on a normalized basis.