Financial due diligence examines what a target's accounts contain and what they leave out: the quality of its earnings, the reality of its assets, the liabilities that have not been recorded, and the obligations that will survive the transaction.
This describes the subject in general terms and is not advice; what applies depends on the facts, and the law changes.
Understanding the service
Due diligence is not an audit and gives no opinion on the financial statements. It is an examination of agreed scope against an agreed purpose, and the scope is the single most important term of the engagement.
Attention usually centres on the quality of earnings, the working capital position, debt and debt-like items, contingent liabilities, tax exposures, related-party dealings and commitments under major contracts.
Findings are only as good as the information provided and the time allowed. Where access is restricted, the limitation is stated in the report rather than papered over.
Buyers often commission a separate tax or legal due diligence alongside the financial work.
When it becomes relevant
- An acquisition, merger or purchase of a business
- An investment, or admission of a new investor
- A seller preparing for a sale and wanting problems identified early
- A lender assessing a borrower before a facility
- A joint venture, where each party needs to understand the other
What the work usually covers, subject to the agreed scope
- Quality of earnings: whether reported profit is recurring and supported
- Working capital trends and the funding the business actually needs
- Debt, debt-like items and off-balance-sheet obligations
- Contingent liabilities, disputes, and tax positions taken
- Related-party transactions and their commercial basis
- Key contracts, commitments and matters affected by a change of control
- A report of findings, with the limitations stated
Framework and sources
The law and professional standards this work is carried out under. Links open the official site.
How the work runs
- Agree scopeSettle the purpose, the periods, the areas covered and the reporting format.
- Request informationIssue an information request and establish access to data and management.
- AnalyseExamine financial information, test the significant items and interview management.
- Raise and resolve queriesPursue open points and record what could not be resolved.
- ReportIssue findings with their implications and the limitations that applied.
A general sequence. Engagements differ, and the scope of each is agreed in writing.
Common questions
Is due diligence an audit?
No. It does not give an opinion on the financial statements. It reports findings within an agreed scope.
Will it uncover everything?
No. It is limited by scope, by the information made available and by the time allowed. Those limits are recorded in the report.
Can the report be shared with a lender?
Only on the terms of the engagement. Reliance by anyone other than the client is a matter to be agreed in advance.