How to Conduct Financial Due Diligence

Financial due diligence revolves around investigating and analyzing the financial performance of a company. It is performed by outsiders to deliver an in-depth understanding of the financial situation that a company is in and the different prospects for its future. Issues that are not apparent in financial statements often become prominent through financial due diligence.

Financial due diligence can offer multiple benefits, including the identification of issues that must be addressed before any agreement is signed. But the benefits will only be available when the process is performed in the right way. The right steps for conducting the financial due diligence process are as follows:

1. Preparation Stage

Before beginning with the financial diligence process, it’s crucial to figure out whether a company is suitable for investments. You need to start by determining whether the business meets your criteria. For instance, you should ask questions about the growth objectives, market demand for the company’s product or services, and its suitability in your industry.

2. Research Stage

After deciding to go ahead with financial due diligence and choosing the target company, you will have to concentrate on some basic research. It involves collecting as much relevant information as possible about the company. As part of your research, you might have to do the following and more:

Communicating with key decision-makers in the target company

Assessing public documents like press releases and annual reports of the company

Asking for copies of internal documents like balance sheets, minutes of board meetings, meeting agendas, and more

Performing third-party audits of the financial statements of the company

Touring the different offices of the company

3. Verification Stage

After the research stage, you must verify the information you have collected. It involves comparing all the data obtained during the research with the company’s original data. The verification stage revolves around the following:

Defining the scope of the financial due diligence process

Identifying the information that is necessary for the process

Evaluating past financial data of the target company

Discussing findings with the key people in the organization

Understanding the impacts of the findings and addressing them with the management

Creating a final report

4. Analysis Stage

After collecting and verifying all the data, you will be required to analyze it thoroughly. While performing a broad analysis of the collected data, you might do the following:

Analyze the historical trends of a company’s revenues and expenses

Comparing the historic revenues and expenses of the company with competitors

Evaluating working capital and cash flow statements

Determining balance sheets to look for signs of mismanagement or fraud

Liabilities, assets, and long-term debt analysis

Checking the existence of any contract or agreement between the company and its customers or suppliers

Conducting market analysis to evaluate the level of competition in the industry

Spotting weaknesses in the operations of the company

Analyzing the products and services of the target company

Performing audit and analysis of the books and records of the company

Investigating the management of the company

Bottom Line

The need for due diligence varies across industries. For instance, manufacturing companies should be more focused on operational due diligence, while a tech firm should be focused on technological due diligence. But every company should conduct a financial due diligence, irrespective of their industry. If conducted the right way, financial due diligence can reveal more about a target company than all other forms of due diligence combined.