Jilian Consultants Co., Ltd.
Jilian Consultants Co., Ltd.

Definition, Importance and Objectives of Financial Due Diligence

Financial due diligence is not an audit as it covers a much larger area. Financial due diligence not only looks at a company's historical financial performance, but also provides a professional and independent opinion about the future. Financial due diligence will explain trends observed in a company's operating results.

Ⅰ. What is financial due diligence?

Financial due diligence is usually performed when a buyer wants to acquire a company. In this case, the buyer needs to have some certainty about the company and the financial position it is in. Therefore, financial due diligence can be described as a project in which a detailed investigation and analysis is carried out to assess the key issues facing the target company's financial operations. A clear focus on the business drivers of its historical and expected profits and cash flows. In addition, the balance sheet and full profit and loss statement will be analyzed in detail.

Ⅱ. The importance of financial due diligence

A financial analysis of the target is important. Buyers need assurances that they understand what risks the company has. Asset (purchase) transactions mean that historical legal liability does not pass to the buyer, which may mean that financial due diligence is shorter and less extensive than transactions that do share acquisitions. However, this is not necessarily the case in all cases. It is important to identify the value drivers of financial performance and ensure that the company's future earnings are sustainable.

Ⅲ. The objectives of financial due diligence

The due diligence process is much more than a checklist of standard procedures for approving a proposed acquisition. When done properly, financial due diligence will provide valuable information to support a proposed acquisition. There are several examples where professional financial due diligence can save the cost of bad acquisitions. Financial due diligence generally has the following objectives:

1. Fully understand the historical financial position of the company and the correctness of the reported figures;

2. Check for hidden "hidden secrets" (exposure financial risks);

3. Fully understand the target company's balance sheet (assets and liabilities, including contingent liabilities);

4. Fully understand the profit and loss of the target company (will the company's historical profit be sustainable in the future?);

5. Predict the future financial situation of the target company (to ensure that the valuation is realistic and the purchase price is reasonable);

6. Determine whether the expected synergy can be achieved (and further confirmed);

7. Find out the purchase price. DD can also be used as a basis for further price negotiations (often seen in practice);

8. See if there is a major disruptor (identify early on what a successful merger will need to address);

9. Understand what guarantees the buyer should require in the SPA;

10. Use financial due diligence reports of external companies to achieve bank financing;

11. Use financial due diligence reports to fine-tune business plans and prepare post-acquisition integration plans.