Financial Due Diligence: Understanding the Numbers Behind a Transaction
Financial due diligence is a critical step when buying, selling, investing in, or recapitalizing a privately held business.
The objective is to understand the company’s true financial performance, sustainable earnings, cash flow, working capital requirements, and key financial risks before completing a transaction.
What Does Financial Due Diligence Review?
A financial due diligence engagement may include analysis of:
- Historical revenue and profitability trends
- Adjusted or normalized EBITDA
- Nonrecurring and discretionary expenses
- Customer and supplier concentration
- Gross margins and operating performance
- Working capital requirements
- Cash flow and capital expenditures
- Debt and debt-like obligations
- Related-party transactions
- Financial reporting quality
The analysis helps identify issues that may affect valuation, purchase price, deal structure, or transaction negotiations.
Quality of Earnings
An important component of financial due diligence is determining whether reported earnings accurately reflect the company’s ongoing economic performance.
A Quality of Earnings analysis evaluates reported EBITDA and identifies adjustments that may be necessary for unusual, nonrecurring, owner-related, or non-operating items.
Because many private-company transactions are priced using a multiple of EBITDA, even relatively small adjustments can have a meaningful impact on transaction value.
For Buyers
Financial due diligence can help buyers:
- Validate reported earnings
- Identify financial risks
- Assess working capital requirements
- Evaluate customer concentration
- Understand cash-flow generation
- Support purchase-price and deal-structure decisions
The objective is simple: understand the business before committing capital.
For Sellers
Due diligence can also be performed before a company goes to market.
A pre-sale financial review allows owners to identify potential issues, document EBITDA adjustments, improve financial reporting, and prepare for the questions prospective buyers are likely to ask.
Early preparation can reduce surprises and help create a more efficient transaction process.
Financial Due Diligence and Business Valuation
Business valuation and financial due diligence are closely related.
A valuation determines what a business may be worth. Financial due diligence helps determine whether the financial information supporting that valuation reflects the company’s sustainable operating performance.
Together, they provide a more complete understanding of the economics and risks of a transaction.
How Sullivan Consulting Can Help
Sullivan Consulting provides Financial Due Diligence, Quality of Earnings, Business Valuation, and M&A Advisory services for privately held businesses, buyers, sellers, and investors.
Our work is designed to provide independent financial insight that helps clients evaluate opportunities, identify risks, and make informed transaction decisions.
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