Financial due diligence
Financial due diligence is the financial examination of a company ahead of an acquisition or investment. It focuses on quality of earnings, working capital, net debt and the robustness of the business plan, so that price and risk can be assessed realistically.
What is examined
The centre of the work is not the statutory accounts as such but the question of which earnings are sustainable – the quality of earnings. Reported EBITDA is adjusted for one-off, out-of-period and non-operating effects; see EBITDA normalisation. Working capital is analysed across the year, net debt is determined including hidden items, and the plan is tested for plausibility.
Why it drives the price
Purchase prices are frequently formed as a multiple of adjusted EBITDA, so every adjustment affects the price multiplied by that factor. The customary working capital mechanism in the purchase agreement also builds on the findings.
Buy side and sell side
Buyers commission it to identify risk and negotiate. Sellers increasingly commission it in advance – as a vendor due diligence – to avoid surprises during the process and protect their negotiating position. The methodology is the same; the focus differs.
Boundary to a statutory audit
An audit confirms that accounting complies with statutory requirements. Financial due diligence is a voluntary, transaction-specific analysis without an audit opinion, but considerably deeper on the questions that determine the price.
What companies should prepare
Reconciled monthly figures over at least 24 months, a traceable bridge from bookkeeping to reporting, documented contracts in a structured data room, and a plan whose assumptions can be explained. Producing all this during the process costs time and negotiating room; doing it in advance is what exit readiness means.
How the review is run or prepared with outside support is set out under Financial Due Diligence.