Definition: What is financial due diligence?
Financial due diligence is about buyers realistically assessing the asset, earnings and liquidity position of the company in which they want to invest.
Most important for buyers and sellers is the company’s expected future earnings strength and cash flow. They are also interested in the target company’s asset situation.
The financing structure is also of interest to buyers. In this context, prospective buyers will check in particular whether liabilities need to be repaid in the short term. Such upcoming payouts would have to be refinanced by the buyers, if necessary.
Sellers will have already trimmed your company to earnings and liquidity strength before the sales process. Prospective buyers will use the earnings strength and any earnings and cash flow risks they identify during financial due diligence to adjust their willingness to pay the purchase price.
Process and procedure of financial due diligence
In the course of a financial due diligence, prospective buyers examine the previous and prospective earnings strength, asset situation and liquidity of their target company. For this purpose, the management of the company to be sold provides meaningful information. As a rule, this information is requested by the prospective buyer and made available by the company for inspection in a data room. Such a data room is now usually offered virtually.
Finally, prospective buyers will also evaluate the assets of the company or business in the financial due diligence process, particularly in the case of a Asset Deal. In a Share Deal, the key criterion for the purchase price is the expected future earnings and not the value of the assets, but the condition of the assets provides information about the company’s performance as a basis for the earnings value. Any investment backlog could have a negative impact on the continued operation of the business, expected earnings and future cash flow. If the utilization of assets depends on specific contracts or even property rights, the value of the assets may be significantly affected as a result and earnings may be jeopardized. In such cases, the outcome of a Commercial Due Diligence and a Legal Due Diligence will affect the financial due diligence. Look for such cross-effects when evaluating companies. Examining intangible assets is also a component of financial due diligence. Assessing the value of intangible assets often requires extensive insight into the industry and a special level of sensitivity. Here, too, the Commercial Due Diligence, the Legal Due Diligence and also the Technical Due Diligence have an impact on the financial due diligence.
Financial due diligence can be completed within 2-4 weeks, depending on the complexity of the company. The results of the financial due diligence form an essential component for the company valuation and are a basis for the guarantees that are agreed in the transaction contract.
Financial Due Diligence Checklist
With a Financial Due Diligence checklist, you can systematically record the earnings, asset and liquidity situation of companies.