Finance Due Diligence Questions

Financial due diligence is a critical process when considering a merger, acquisition, investment, or any significant business transaction. It provides a thorough examination of the target company’s financial health, performance, and future prospects. Asking the right questions during this process is paramount to making informed decisions and mitigating potential risks. Here are some key areas and questions to consider:

Financial Statement Accuracy & Reliability

• Have the financial statements been audited? If so, by whom and what was the opinion? Request copies of the audit reports and management letters.
• Are there any qualifications or disclaimers in the audit report? Understand the implications of any such findings.
• What accounting policies are used? Are they consistent with industry standards and consistently applied across reporting periods?
• How are revenue, expenses, assets, and liabilities recognized and measured? Request details of specific accounting treatments.
• What is the quality of the underlying accounting records and internal controls? Request documentation and assess the robustness of the systems.

Revenue and Profitability

• What are the key revenue streams? Analyze the revenue mix, customer concentration, and sales trends.
• What are the gross profit margins? Investigate fluctuations and compare them to industry benchmarks.
• What are the operating expenses? Analyze the major cost drivers and identify any areas of potential inefficiency.
• What is the company’s pricing strategy? Understand the basis for pricing decisions and competitive pressures.
• What is the customer churn rate? High churn can indicate underlying problems with product or service offerings.

Balance Sheet Analysis

• What is the quality of the assets? Evaluate the collectibility of accounts receivable, the obsolescence of inventory, and the impairment of fixed assets.
• What are the major liabilities? Review the terms of debt agreements, including interest rates, maturity dates, and covenants.
• Are there any contingent liabilities, such as pending litigation or environmental claims? Assess the potential financial impact.
• What is the working capital position? Analyze the company’s ability to meet its short-term obligations.
• What is the equity structure? Understand the ownership and any potential dilution.

Cash Flow

• What are the historical cash flow trends? Analyze cash flow from operations, investing activities, and financing activities.
• What are the major sources and uses of cash? Identify any significant cash flow dependencies.
• How is cash managed? Review the company’s cash management policies and procedures.
• What is the free cash flow? Analyze the amount of cash available to the company after investing in its business.
• What are the capital expenditure requirements? Understand the ongoing investment needed to maintain and grow the business.

Debt and Financing

• What is the company’s debt-to-equity ratio? Assess the level of financial leverage.
• What are the terms of the debt agreements? Review interest rates, covenants, and repayment schedules.
• Are there any upcoming debt maturities or refinancing requirements? Understand the company’s ability to meet its obligations.
• Does the company have access to additional financing if needed? Explore available credit lines or other sources of capital.

This list is not exhaustive, and the specific questions asked will depend on the nature of the transaction and the specific circumstances of the target company. Engaging experienced financial advisors and legal counsel is crucial to conducting a thorough and effective due diligence process.