Financial Due Diligence

Identify and assess risks or "red flags".

What is Financial Due Diligence?

Financial Due Diligence in M&A is the process undertaken typically by an Accountant to investigate, review and consider the reasonableness of the financial performance and financial position of a target entity. The goal is to identify and assess risks or "red flags" which are crucial in the decision making of an acquirer in a transaction. Uncovering these risks during the financial due diligence stage can save the acquirer significant time and money.

Financial Due Diligence covers:

Historical Financial Performance: revenue, gross margin, EBITDA and EBIT.
Quality of Earnings (QoE): reported financial performance including adjustments for non recurring or abnormal items uncovered during the financial due diligence.
Financial Position: assets, liabilities and equity.
Working Capital and Net Debt: identify trends and abnormalities in the typical operations of the target entity as well as any financial debt and off balance sheet exposure to the acquirer which are negotiated during the financial due diligence process and meticulously drafted into the contract of sale.
Recurring and non recurring revenue: identify sticky customers and churned customers and the trends over the historical period.

Why is Financial Due Diligence important?

Financial due diligence empowers the acquirer in a number of ways:

Risk identification: financial due diligence delves deeper into the finance function of a target entity beyond the face of the financial reports. An acquirer who is informed of any risks early is better equipped to make the decision to proceed with the transaction and steer negotiations with he vendor.
Supporting the valuation: a clear understanding on normalised earnings (QoE), working capital and net debt are fundamental to the Enterprise Value to Equity Value bridge.
Acquirer confidence: being informed on risks and having a independent representation of the factual findings of the financial due diligence gives the acquirer and other stakeholders to transact with confidence.