CTA Due Diligence & Forensic Analysis in Turnaround 2 — Questions and Answers
Question 1: What is 'normalized EBITDA' and why is it important in turnaround due diligence?
- EBITDA adjusted for inflation to reflect current purchasing power in real terms
- EBITDA adjusted for non-recurring and one-time items to reflect underlying business performance (Correct answer)
- The simple average EBITDA calculated over the prior five fiscal years
- EBITDA calculated before any management fees or related-party charges are deducted
Correct answer: EBITDA adjusted for non-recurring and one-time items to reflect underlying business performance
Normalized EBITDA adjusts for non-recurring items to reveal underlying business performance, which is essential in distressed situations where financial statements often contain unusual charges that obscure true operating economics.
Question 2: In forensic analysis, what is 'kiting' in the context of a distressed company's cash management?
- A strategy to reduce outstanding debt through systematic asset dispositions
- A fraudulent scheme using float between bank accounts to artificially inflate cash balances (Correct answer)
- A legitimate cash management technique to optimize daily account balances
- A method to calculate the effective interest rate on revolving credit facilities
Correct answer: A fraudulent scheme using float between bank accounts to artificially inflate cash balances
Kiting is a fraudulent scheme where funds are moved between accounts to exploit check clearing time, artificially inflating cash balances and deceiving lenders and auditors about actual liquidity.
Question 3: Which analytical technique is most useful for detecting fictitious or manipulated revenues in a distressed company?
- Discounted cash flow analysis using management projections
- Benford's Law analysis of the distribution of leading digits in financial data (Correct answer)
- Net present value calculations applied to revenue streams
- SWOT analysis of the company's competitive position
Correct answer: Benford's Law analysis of the distribution of leading digits in financial data
Benford's Law analysis examines the statistical distribution of leading digits in financial data; deviations from the expected natural pattern can indicate fabricated or manipulated numbers in large financial datasets.
Question 4: What is a 'preference payment' in the context of bankruptcy forensic analysis?
- A payment made to preferred shareholders prioritized over common stockholders
- A payment made to a creditor within 90 days before bankruptcy that may be clawed back (Correct answer)
- A distribution made during bankruptcy proceedings to secured creditors in priority order
- An interest payment contractually granted seniority over other creditor payments
Correct answer: A payment made to a creditor within 90 days before bankruptcy that may be clawed back
A preference payment is made to a creditor within 90 days before bankruptcy filing (one year for insiders) and may be recoverable by the bankruptcy estate as it gives preferential treatment over other similarly situated creditors.
Question 5: When reviewing a distressed company's inventory during forensic analysis, what should the analyst be most alert to?
- The number of different SKUs maintained across the entire product line
- Overstated inventory values, obsolete items, and discrepancies with physical counts (Correct answer)
- The geographic distribution of warehouse and inventory storage locations
- Normal seasonal fluctuations in raw material and finished goods inventory levels
Correct answer: Overstated inventory values, obsolete items, and discrepancies with physical counts
Forensic analysts must be alert to overstated inventory values, obsolete items, and physical inventory shortfalls as these materially overstate assets and can mask the true severity of a company's financial distress.
Question 6: What does 'substantive consolidation' mean in the context of complex bankruptcy proceedings?
- Consolidating multiple divisions of a company into a single streamlined operating entity
- Merging the assets and liabilities of related entities and treating them as a single debtor (Correct answer)
- The process of combining financial statements of subsidiaries for audit reporting purposes
- Reducing the number of creditor classes to simplify a plan of reorganization
Correct answer: Merging the assets and liabilities of related entities and treating them as a single debtor
Substantive consolidation merges the assets and liabilities of related entities as if they were a single debtor, often pursued when assets have been commingled and separate corporate identities have been routinely disregarded.
Question 7: In due diligence for a leveraged buyout gone wrong, what is most important to analyze regarding the debt structure?
- The creditworthiness and capital adequacy of the original lenders at the time of the LBO
- The terms, covenants, maturity schedule, and cross-default provisions of all debt instruments (Correct answer)
- The personal financial statements of the selling shareholders at the time of the transaction
- The original investment thesis and return expectations of the private equity sponsor
Correct answer: The terms, covenants, maturity schedule, and cross-default provisions of all debt instruments
Understanding the complete debt structure including covenants, maturity schedule, and cross-default provisions is critical to identifying constraints, triggers, and options that will shape the available turnaround strategies.
CTA Due Diligence & Forensic Analysis in Turnaround 2
What is 'normalized EBITDA' and why is it important in turnaround due diligence?