Financial due diligence is a key process in M&A, and arguably is the most important, non-negotiable type of due diligence undertaken before a deal. 

However, it’s important to remember that skipping any aspect of due diligence could result in loss of time, money and even the deal itself.

Financial due diligence, also known as accounting due diligence, is probably the most easily understood part of M&A. After all, it’s obvious that an organization looking to acquire or merge with another business entity needs a thorough understanding of that target company’s financial state.

Let’s explore the basics of financial due diligence, from the buy and sell side perspective, how long it takes, and exactly what information needs to be scrutinized. We even provide a checklist so you can proceed with confidence.

What is financial due diligence? 

Financial due diligence assesses the financial health of a business. During the financial due diligence process, the company’s historical and current financial performance is put under the microscope in order to establish future forecasts and identify any potential risks.

Financial due diligence aims to determine whether a company’s financial information is true and accurate. This helps the buy-side in M&A transactions or potential investors to better understand the company’s core performance metrics.

What documents and data are needed for financial due diligence?

Financial information to be reviewed during this type of due diligence includes:

• Audited financial statements

• Balance sheets

• Assets and liabilities

• Cash flows

• Capital expenditures

• Projections 


The aim of this process is to determine whether they are true and accurate. 

What is financial due diligence vs a financial audit?

Financial due diligence goes beyond a financial audit. While a financial audit will verify the accuracy of the income statement, balance sheet and cash flow reports, the financial due diligence process looks behind the numbers to discover if the figures are sustainable and whether there are any hidden liabilities or risks. 

This helps the buy-side to get a better understanding of the company’s core performance metrics, including whether past performance accurately reflects the company’s future potential. 

Financial due diligence for the sell-side

In mergers and acquisitions, we generally think of the buyer performing due diligence. However, it's important for the company being acquired to do their due diligence too. Why? Because 46% of deals fail due to issues surfaced during the due diligence process. So, if the sell-side can perform due diligence on their own company first, issues can be identified and gaps filled before the buyer gets involved.

Preliminary due diligence, before the buyer submits a letter of intent, is usually limited in scope but it still covers the most recent balance sheet, profit and loss statement and statement of retained earnings. A more thorough due diligence follows the letter of intent and confidentiality agreement. Sellers should ensure that financial information is organised, easy to navigate and supports the claims made during the initial conversations. 

This will make for a more seamless transaction. The financial due diligence process may potentially reveal a higher fair market value than the seller initially anticipated, making it worthwhile to prepare a due diligence report ahead of the M&A process. 

Financial due diligence for the buy-side

Financial due diligence is the first step towards buyer confidence during an M&A deal. A thorough understanding of the target's financial health and prognosis can mean the difference between a sound investment and a failed merger or acquisition.

The most common way to proceed is to analyze financial statements, order forecasts, market and industry data, and even interviews with key employees. Because of the sensitive nature of this information, the buyer and seller will need to share documents in a secure data room.

How long does the financial due diligence process take?

An average small business can expect due diligence to take around 45-60 days. In. This is usually enough time for the buyer to complete a thorough evaluation of the business, including the financial aspects. For larger or more complex deals, due diligence make take 60 to 180 days

However, if the seller goes into the deal unprepared, the process can be more time-consuming. This is why always-on readiness on the sell side is essential to a successful deal that realises the optimal value of the selling company.

Financial due diligence checklist

Our financial due diligence checklist covers everything you need to get ready or review (depending on whether you're sell or buy-side) during an M&A deal.

Below is a basic outline of the financial due diligence checklist:

• Income statements (past five years) showing income and expenditure, profit and loss
• Balance sheets (past five years) showing company assets and liabilities
• Cash flow statements (past five years) showing all cash inflows and cash outflows
• Management discussions around financials, including meeting minutes and emails
• Operating margin, reflecting the percentage of profit the company produces from its operations before subtracting taxes and interest charges
• Gross margin (amount of money left after subtracting all direct costs of producing or purchasing company goods or services)
• Profit margin, i.e. net income divided by net sales or revenue
• Interest coverage (earnings before interest and taxes divided by interest expense)
• Debt to equity ratio, showing how much debt there is compared to assets
• Asset turnover, showing how many sales were generated from every dollar of company assets
• Return on assets, showing level of efficiency in earning profit from company resources
• Return on equity, i.e. net income divided by shareholder equity
• Tax due diligence, showing direct and indirect taxes the company is liable to pay 

To get more detail on all the documentation you’re going to need, download the financial due diligence checklist now.

The best advice we can give you for a seamless due diligence process if you're the seller is to prepare well in advance of your business exit. There's a lot of information to get ready and the last thing you want is to waste bidders' time. However, if you are selling a business in a hurry, Ansarada Deals is your best solution.

Ansarada Deals brings together a purpose-built set of solutions into one fully integrated platform that delivers value across the complete deal lifecycle. Centralize all your deal activity with Deal Workflow™, project management tools, advanced data rooms, AI deal insights, and post-merger integration frameworks.

Now you can control every aspect of your transaction from start to finish.

 

Financial due diligence FAQ

What is done in financial due diligence?

Financial due diligence means auditing or investigating the financial records of a company before entering into a transaction. Financial due diligence confirms on the data that the information provided in initial conversations and document sharing is true and correct. 

What is an example of financial due diligence?

An investor may undertake financial due diligence of a company ahead of committing to invest to determine the accuracy of financial record keeping, any red flags such as tax debt or misstatement of numbers and any opportunities to turn cost centres into profit centres or find efficiency in the business. 

What are the three pillars of financial due diligence?

Financial due diligence can be thought of as having three pillars: 

1. Income statement analysis
2. Balance sheet examination
3. Cash flow statement insights. 

Each of these reveal any discrepancies between claims made and the actual financial behaviours and circumstances of a company.