Experts in the finance industry agree that financial due diligence is an area that requires a significant amount of attention from businesses, small and big alike. Hundreds of businesses rely on Company Watch to streamline their financial due diligence process and ensure comprehensive coverage.
Financial due diligence is key for effective risk management and protection against fraud. But to conduct a holistic due diligence check, you must first understand what it is and how it benefits the organisation you work for. In this article, we take an in-depth look at the following:
What is financial due diligence?
Financial due diligence is the process of analysing the financial performance and health of a company. It helps you understand how financially secure a company is so that you’re able to make business decisions without running the risk of insolvency or potential fraud. Financial due diligence also shows you a company’s future potential so that you can decide on the length of your partnership with them.
The benefits of financial due diligence
1. Mitigating risk
According to a report by BDO, business fraud has increased by 104% since 2022. This is having a huge detrimental impact on the way business is conducted.
A thorough financial due diligence process sheds light on the following key risk factors:
- Level of financial stability
- Potential fraud and misrepresentation of documents by the company
- Any pending lawsuits or tax liabilities
- How sustainable the profits are
- Industry standing relative to peers
By successfully identifying any red flags that come up, you’re able to make a more informed decision about whether or not you want to enter into a partnership with the company.
2. Building trust
Financial due diligence isn't just about numbers; it's also about building trust. When you conduct a thorough financial review of a potential partner, you're essentially saying, "I've done my homework, and I'm confident in this deal."
It also goes the other way around. If a company is forthcoming with providing the necessary documentation to verify their financial standing, you can trust that they will be easy to work with and the partnership process will be smooth. On the other hand, if a company is not willing to provide this documentation, that may be a red flag to consider in itself.
3. Allowing for informed re-negotiations
A holistic financial due diligence process will pinpoint exactly what the red flags are in a company’s financial statements. As long as these red flags are issues that can be dealt with, the due diligence report can inform any re-negotiations needed to continue with the partnership, whatever they may be.
This is fundamental in the risk management process. It means that you can come from a more informed place when talking to potential partners. It also helps you conduct a potential fraud check. Armed with facts and evidence, you can set new terms with confidence.
4. Saving post-transaction time
Conducting a thorough financial check before signing a deal can make post-transaction paperwork a breeze. This is because you don’t have to constantly look over your shoulder, worried that something unusual or concerning might come up.
Financial due diligence also saves you time in the long run. Essentially, it makes it less likely for issues to arise in the months and years after the deal is signed.
Your due diligence checklist
Now that we have established the importance of financial due diligence, what do you need to look for when conducting it? Below is a due diligence checklist that covers the main areas to look at:
- Financial statements e.g. balance sheets and tax returns
- Management information e.g. director biographies and corporate governance practises
- Financial ratios e.g. profitability ratios and solvency ratios
- Pending lawsuits and tax compliance
- Any pending claims
- Comparable company analysis
- Due diligence report with key findings explained, including overall level of financial risk
This due diligence checklist is not exhaustive. There will be other factors to consider depending on the type of due diligence you are conducting.
Conducting your financial due diligence effectively
Financial due diligence is not a place to cut corners in business. It is essential to allocate time and money to ensure that the businesses you choose to partner with are solid.
Since its establishment in 1998, Company Watch has helped businesses in the UK enhance their risk management process. Our EDD reports clearly set out risks with detailed evidence, audit trails, and a list of all sources used. We lay this information out in an accessible format, so that you can share them with the necessary stakeholders with confidence.
You can also conduct a due diligence check on your own business with Company Watch. We analyse data across publicly-available sources as well as our own host of resources to create a comprehensive EDD report for you.
Key takeaways
- Financial due diligence can help you mitigate risk and fraud, while building trust with potential partners.
- There are a few standard factors to include in your due diligence checklist. However, there may be more factors to consider depending on the type of due diligence you are conducting.
- Always use a trusted business information provider like Company Watch for a comprehensive due diligence report.
