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What is Financial due diligence?

Financial due diligence is the detailed investigation about the financial statements of the target company to understand the financial performance of the company. It is a deep analysis of historical trends to confirm the relevance of these trends.

Table of Content:

1. Meaning of Financial Due Diligence 

2. Types of financial due diligence

3. Financial Due Diligence Services

4. Financial due diligence checklist

5. Benefits/ importance of Financial Due Diligence

6. How to conduct Financial due diligence

7. Financial Due Diligence Report

8. FAQs

Meaning of Financial Due Diligence

Financial due diligence is basically an investigative analysis of potential deals. It is done by the outsider to understand the financial performance of a company. The current financial situations and facts are revealed so that buyers can take the investment decision accordingly. 

Financial due diligence Services helps the buyer to have a grip on the financial affairs of a company. Financial due diligence sets out to uncover the issues which are not evident in financial statements.

Types of Financial Due Diligence

1. Financial due diligence Sell-Side

It is important for the sell-side to do their own due diligence to have a uniform transaction with the buyer. If the sell-side performs its own due diligence, then issues can be rectified prior to the buyer getting involved. Sell-side shareholders get to know about any financial issue if it arises and the same can be resolved before entering into any deal.

2. Financial due diligence Buy-Side

Financial due diligence on the buy-side is conducted to have a detailed investigation of the information which is provided by the target company. This process is done by the acquiring party for transaction advisory and knows about the financial health of a company. Issues and risks are to be identified which can affect the deal.

Financial Due Diligence Services

1. Assess the issues and risks involved in the business.

2. Identify the financial risk involved which has the power to impact on decisions of investors.

3. Check the fixed assets (Physically, recorded and depreciation etc.)

4. Checks the receivables and payables of a company.

5. Working Capital

6. Quality and reliability of financial statements.

Financial Due Diligence Checklist

1. Income Statement: Firmly examine the expenses of a company, if there are any irregular expenses made by the company. It’s important to monitor the operating expenses and the profit margin. Like travelling expenses are highly increasing, or salary is growing faster than the revenue of the company. 

2. Balance Sheet: Company’s balance sheet shows assets and liabilities. Evaluate the assets of the company, as assets are not recorded above the fair market value. Valuation of assets to be evaluated. Check the debt level of a company and how it is compared with the industry.

3. Cash Flows: Check the cash flows whether it’s positive or not, discern the reasons behind growing cash flows, is the company selling off their assets or because of operational activities. Scan the quality of cash flows.

Benefits Of Financial Due Diligence

1. FDD makes both the parties take decisions wisely

2. Helps in understanding the financial statement of a company.

3. Issues are recognised which helps the buyer to take the buying decision.

4. Identifies the strength and weaknesses of a company.

5. Provides transparency to the buyer.

6. Get to know about the financial performance of a company.

How to Conduct Financial Due Diligence

1. Planning: 

a.Understanding the business of the target company.

b.Does the target company meet your objective of yours?

c.What is the financial performance of the company?

2. Research:

a.Review the financial data of the target company.

b.Check the accounting policies and practices which are followed.

c.Evaluate the quality of earnings.

3.Verification/ Analysis:

a.Analyse the income statement of the target company.

b.Balance sheet is to be analysed to know any signs of mismanagement.

c.Cash flows and working capital is to be analysed.

d.Verify the assets of the target company, physically also.

e.Liabilities and long-term debt analysis.

4. Financial Due Diligence Report

 A.The objective of FDD is to summarise the findings which have been found in the process of due diligence. It should distinctly state the issues found during the investigation. 

b.The report should provide recommendations to improve the issues to the target company. 

c.The report must contain the findings along with its solution for the target company in closing the potential deal.

Financial due diligence is conducted by the acquiring party. Acquiring party can perform due diligence with an in- house team or can outsource to due diligence professionals

Yes, it clearly states the financial health of the target company which is important before entering into the agreement.

Deals with the detailed investigation of financial statements of the target company. The team work is to understand the challenges, trends of a company. Finding the shortcomings of a company along with the solutions to have a seamless transaction.

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