All About Financial Due Diligence

Are you looking to secure investment funding in order to take your business to the next level?

If so, then you need to know what financial due diligence is and why it matters.

Ultimately, you won’t stand a hope of gaining investor approval if your business financials don’t check out after due diligence has been performed. This is why it’s so crucial for you to understand it and thoroughly prepare for it before the process starts.

Here’s everything you must know about it.

What is Financial Due Diligence?

In a nutshell, financial due diligence is the process potential investors follow when they need to evaluate the financial performance, position, and prospects of a business. 

This is a vital step to take before making an investment decision as it determines whether the business qualifies as suitable for funding.

Financial due diligence consists of analyzing the historical and projected financial statements, budgets, forecasts, cash flows, working capital, debt, tax liabilities, contingencies, and other financial information of the target company. 

By doing so, potential investors can better identify the risks and opportunities associated with the target company, assess its valuation, and deal structure, and negotiate the terms and conditions of the transaction.

Who Carries Out Financial Due Diligence?

Financial due diligence is typically conducted by a team of financial professionals with expertise in accounting, finance, taxation, and valuation. 

These individuals could consist of internal staff from the investor’s organization, external advisors like auditors, consultants, and lawyers, or a combination of both. 

Why Is Financial Due Diligence Important?

If you are a business owner who is seeking investment, here’s why financial due diligence matters:

  • It verifies the accuracy and reliability of the financial information you provide
  • It assesses the quality and sustainability of the earnings, cash flows, assets, liabilities, and equity of your business
  • It identifies any hidden liabilities, contingencies, or off-balance sheet items that may affect the value or structure of the deal
  • It can help to determine the appropriate valuation and price for the deal, based on the financial performance and prospects of your business

What Are the Steps of Financial Due Diligence?

Financial due diligence is a complex process but when broken down, it typically involves the following steps:

  1. Request and review financial documents: Including audited financial statements, management accounts, budgets, forecasts, tax returns, contracts, and more.
  2. Interviews with business owners and stakeholders: This allows investors to understand the business model, strategy, operations, customers, suppliers, competitors, etc.
  3. Financial analysis and modeling: This is done to assess the historical and projected financial performance, growth, profitability, liquidity, solvency, efficiency, and risk of the business.
  4. Industry benchmarking comparison: This evaluates the business’s competitive position and overall market share.
  5. Adjustment identification: Reported financial figures may require adjustment to reflect the true economic reality of the business, such as non-recurring items, non-operating items, related-party transactions, etc.
  6. Quality assessment: This determines the quality and reasonableness of the projections used to estimate future cash flows and earnings potential.
  7. Risk evaluation: A process to uncover risks associated with the business plan, market conditions, regulatory environment, customer base, product portfolio, etc.
  8. Fair value and deal price estimation: Using various valuation methods and techniques, such as discounted cash flow (DCF), multiples analysis, net asset value (NAV), etc. the amount of funding is determined.
  9. Due diligence report: A final document summarizing the findings, conclusions, recommendations, and key issues of the whole due diligence process.

What Are the Challenges of Financial Due Diligence?

Financial due diligence can be challenging for several reasons.

Firstly, it can be time-consuming and costly to obtain and analyze all the relevant financial information and data from the target company. It can also be difficult for potential investors to access confidential or sensitive information from the target company. 

Therefore, potential investors must already be reasonably confident that the deal will be worth their time and effort.

Additionally, you should lay the groundwork before approaching an investor and gather or make available all the information readily available. If you’re clear and transparent throughout the whole process, this is going to make it easier and faster for the investor to reach a decision.

 

How Should a Business Prepare for Financial Due Diligence?

If you do plan to approach a potential investor in the near future, you will do well to prepare yourself and your business to receive the due diligence process. 

Some of the steps you need to follow are:

Preparing this information ahead of time shows that you are serious and dedicated to securing investment. 

How to Seek Help for Financial Due Diligence

We understand. Due diligence requires a lot of information and if you’re not a financial expert, you quite possibly don’t understand how or where to obtain it.

This is where you can enlist the help of a financial professional. 

At Finvisor, we specialize in providing expert financial services to startups and young and small businesses. Our job is to help these organizations succeed in securing the investment they need to succeed. 

If you need help with the financial due diligence process, Get in touch with Finvisor to discuss our affordable CFO and advisory services today.

*This blog does not constitute solicitation or provision of legal advice and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.*

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