Financial Due Diligence

A quality of earnings analysis is a component of financial due diligence that examines the sustainability and reliability of a target's reported earnings. It identifies adjustments to reported EBITDA that arise from non recurring items, one time costs or revenues, accounting policy differences, revenue recognition inconsistencies, and related party arrangements that distort the underlying earnings base. The output a normalised EBITDA figure is the earnings measure on which the transaction valuation is based, and material QoE adjustments directly affect the purchase price.

Net working capital analysis examines the target's current assets and current liabilities to establish the level of working capital that is normal for the business at a point in time and that the buyer should expect to receive at closing. This normalised level forms the working capital peg in the Sale and Purchase Agreement, and any shortfall in actual closing working capital relative to the peg is typically an adjustment to the purchase price. A peg that is set without proper normalisation ignoring seasonality, distortions in debtor or creditor balances, or one time items is a consistent source of post-closing disputes.

Debt like items are obligations of the target business that, while not classified as financial debt on the balance sheet, have the economic character of debt they represent claims on the enterprise's cash flows or assets that reduce the value available to equity holders. Common debt like items include contingent tax liabilities, pension obligations, deferred consideration on prior acquisitions, lease liabilities, customer deposits, and guarantees extended on behalf of related parties. In an enterprise value to equity value bridge, debt like items are deducted from enterprise value alongside financial debt and missing them results in the buyer paying equity value for liabilities it is assuming.

Vendor due diligence is a financial due diligence report commissioned by the seller of a business and made available to prospective buyers as part of the sale process. A seller should consider commissioning VDD when the target has complex financials that are likely to generate extensive buy side diligence queries, when the seller wants to control the narrative around normalisation adjustments and working capital, when a competitive sale process makes multiple parallel buy-side diligence exercises impractical, or when the seller wants to identify and address material findings before they are discovered by buyers and used as a basis for price reduction.

A statutory audit provides an opinion on whether the financial statements give a true and fair view of the company's financial position in accordance with the applicable accounting standards. Financial due diligence is not an audit it is an analytical exercise that goes beyond the reported financials to examine the quality and sustainability of earnings, the normalised working capital position, the full spectrum of contingent liabilities, and the financial risks that are relevant to the transaction. Due diligence findings are specific to the transaction context and are presented as findings and observations, not as an audit opinion.

A well organised data room for financial due diligence should include three to five years of audited financial statements, monthly or quarterly management accounts for the current and prior two years, tax returns and assessments for all open years, banking facility documentation, material customer and supplier contracts, details of all related party transactions, details of pending litigation and contingent liabilities, fixed asset registers, and details of any off balance sheet obligations. The completeness and organisation of the data room directly affects the speed and quality of the diligence process gaps in the data room typically translate into management information requests that delay the transaction timeline.

For a standard buy side or vendor due diligence engagement on a single entity or simple group target, the process from data room access to final report delivery typically takes three to four weeks. More complex engagements involving multi entity groups, targets with incomplete financial records, or transactions requiring simultaneous tax and legal diligence coordination typically take five to seven weeks. Closing or confirmatory diligence, which involves a more focused review of specific items identified in earlier diligence phases, can typically be completed within one to two weeks depending on the scope and data availability.