Whether you are buying a business, selling one or bringing in an investor, the agreed price is only as good as the numbers behind it. Financial due diligence is how buyers test those numbers before they commit. Knowing what it covers helps buyers ask the right questions, and helps sellers avoid issues that can cut the price or delay completion.
The purpose of financial due diligence
Due diligence answers a simple question: is this business what it appears to be? It tests whether historical profits are sustainable, whether the balance sheet hides liabilities, and whether the forecasts behind the valuation are realistic. The findings feed directly into the price, the deal structure and the protections written into the purchase agreement.
Quality of earnings
Most valuations are a multiple of earnings, so the quality of those earnings is usually the heart of the review. A quality of earnings analysis adjusts reported profit for items that will not continue under new ownership, such as:
- One-off costs or income, like a legal settlement or insurance claim
- Owner-related expenses or salaries that differ from market rates
- Changes in accounting policies or year-end adjustments
- Revenue that depends on a contract that is ending
The result, often called normalized or adjusted EBITDA, shows the sustainable profit a buyer is actually paying for.
Net working capital
Buyers expect a business to come with a normal level of working capital: receivables, inventory and payables in line with how it usually trades. Due diligence establishes that normal level, and the price is often adjusted if the working capital delivered at completion is higher or lower.
Net debt and debt-like items
Beyond bank loans, due diligence looks for obligations that behave like debt, such as unpaid taxes, deferred revenue, overdue supplier balances, lease liabilities or unpaid bonuses. These usually reduce the amount paid for the shares.
The headline price is only part of the story. What matters is the quality of the earnings and the cash behind them.
Tax exposures
A review of the tax position identifies unpaid liabilities, aggressive positions and compliance gaps that could become the buyer’s problem after completion. Findings are commonly handled through price adjustments, specific indemnities or changes to the deal structure.
How sellers can prepare
Sellers who prepare early usually get a smoother process and a stronger price. A sale-readiness review typically includes:
- Tidying up the accounts and resolving long-standing reconciliation issues
- Separating personal and one-off costs so earnings are easy to normalize
- Preparing a clear data room with contracts, leases and key customer information
- Commissioning a vendor due diligence report so issues are understood before buyers find them
Getting independent advice
Due diligence works best when it is independent and focused on the risks that matter for your deal. Our transaction advisory team supports buyers, sellers and investors in small and mid-sized transactions, from the first look at the numbers through to post-deal integration.
This article is general information only and is not tax, legal or financial advice. Rules differ between jurisdictions and change over time, so please speak to an advisor about your circumstances.
