Financial Due Diligence – an Overview

Whenever you are looking to make an investment such as the purchase of a business, a merger, Management Buy-Out (MBO) or Management Buy-In (MBI), financial due diligence will reassure the Purchaser that the business financial performance is as exactly portrayed by the Vendor, providing you with the confidence to proceed with the transaction. If not, the deal may fall through, be renegotiated or the level of warranties may need to be increased to cover potential future claims, such as the realisation of unforeseen tax liabilities etc.

As a Purchaser, you will (hopefully) have already received copies of financial information such as the position on Debtors & Creditors, details of Assets, Statutory Accounts, Management Accounts and Budget or Forecasts for year(s) ahead. Based on all of this, you would have formulated an “Indicative Offer” subject to Heads of Terms being agreed and “Subject to Due Diligence” which will be carried out whilst the Purchase Agreement is being drafted up (after Heads of Terms have been signed).

What is Financial Due Diligence & How does it work?

Financial Due Diligence is a way to uncover and assess any undisclosed underlying risks on a potential deal, allowing the Purchaser to conclude how attractive the deal is, based on the proposed terms.

It is similar in some ways to a statutory audit, as it checks and verifies the company’s numbers, looking at financial performance in relation to the assets and liabilities.

As well as the historic information, it is important to look at the underlying assumptions around the future to determine whether they are realistic.

All due diligence assignments are different and will have differing levels of complexity. Typically, financial due diligence will include such items as:

  • A review of the prior year’s financial statements in detail.
  • A review and critique of the company’s future forecasts, whilst discussing the future outlook with the current business owners and the related assumptions behind the forecasts.
  • An analysis of the company’s cash-flow and cash positioning, including any seasonal trends.
  • A review and verification of the current equity structure, liaising with the company’s lenders to verify the accuracy and to identify any concerns that they may have.
  • A spot check on physical assets (including sample testing on items of stock) held by the company.

The scope of the financial due diligence project can be widened (or integrated with other forms of due diligence) if necessary, to include items such as:

  • An assessment of the company structure and the impact any deal may have on this, including all intergroup relationships.
  • A review of all staff contracts and any other areas susceptible to HR risks.
  • An assessment of the Transfer of Undertakings – Protection of Employment (TUPE) requirements, should a full takeover happen.
  • The use of specialists to carry out valuations on obscure areas of Intellectual Property Rights (IPR) and other assets.
  • An evaluation on compliance and regulatory landscape, to assess risk areas that may materially affect the numbers.
  • The preparation of a Business Valuation, taking the underlying risks and the above points into account.
  • The disclosure and discussion of all concerns and queries on risk areas with the owners of the target company and relay information back to the Purchaser.

When should Financial Due Diligence take place?

Basically, only when both parties have agreed to the deal, accepted the indicative offer and signed the Heads of Terms document. Otherwise, without a deal in place, money will probably be wasted.

How long does Financial Due Diligence take?

The due diligence assignment can take anything from a couple of weeks to many months, depending on the complexity of the deal.

Where does Financial Due Diligence take place?

Due to advances in technology, much of the due diligence project can be carried out remotely. However, certain checks need to be carried out where the assets are located, such as an office, factory or warehouse.

Need help with Financial Due Diligence?

Most business acquisitions need Financial Due Diligence, even if integrated with other forms of Due Diligence. Stirling partners with a Financial Due Diligence Specialist who are award winning Chartered Accountants & Strategic Business Advisors. For further information, simply complete the form below:

Article kindly produced with help from:

Joe Sword ACA
Strategic Consultancy Director
Address: The Retreat, 406 Roding Lane South, Woodford Green, Essex IG8 8EY
Award Winning Chartered Accountants & Strategic Business Advisors