What Is Financial ‘Due Diligence’ And Why Is It Needed?
Posted on 20th July 2022
Accountants and bookkeepers use a process called ‘due diligence’ to understand your financial and business processes. It’s often used as part of an external audit. Small businesses often also go through a financial due diligence process with banks, lenders or investors to assess their overall business health and growth potential.
It’s especially important if you are planning to sell your business because a potential buyer will want to have a clear picture.
If you’re considering starting a project with a new customer, you might also carry out a similar process with them so you fully understand the implications of working together. This is called customer due diligence.
If you start to work with a new bookkeeper, for example, they will want to confirm as a minimum your name, with an official document that includes your photograph such as a passport or driving licence, your date of birth and your home address.
What the financial due diligence process involves
Overview – the process often begins with you, as the business owner. It might involve confirming your identity, finding out more about your experience in business and your skills for managing and running a company. Other factors might include your business location, the goods or services you provide and your customer type.
People – if you have employees, your recruitment, pay, training and policies might also be reviewed to make sure you are meeting all the human resource requirements to run an effective business. If you are considering selling your business your company culture could be important too.
Risk – there are risks involved in every type of business so your risk management processes are important. This part of the process will look at how you protect your financial and business assets from various risk factors. This might include confirming that you have the right level of insurance, capital reserves and suitable emergency and disaster recovery plans.
Assets – your business assets represent part of the value of your business, so they need to be accurately recorded in a financial statement. As part of the due diligence process the information included in your general ledger will be cross-checked with your physical assets. Because many assets lose value over time depreciation will be taken in to account.
Liabilities – you might have loans, credit arrangements, outstanding invoices and other financial commitments that will affect the overall value of your business. The due diligence process is likely to include a review of your current and past accounts, the terms of outstanding debts and discussions with a sample of the people or organisations you have yet to repay.
Equity – you might invest your personal savings in your business as a loan or as equity.
Equity allows you to get your business started, but you might not be able to convert your investment to cash when you want to because your business still needs the funds. The due diligence process will look at how much money you might want to withdraw from the business in the future.
Cash – cashflow is important for the health of your business so the due diligence process will confirm that your net income can cover your outgoings and credit sales to stay healthy, allowing for seasonal trends and inflation for example.
Projections – the process might also include any financial projections you have made for the future performance of your business to confirm that they are based on past performance, accurate information, and that they are realistic.
Please get in touch if you would like to know more about financial due diligence.
Tagged as: Assets, Bookkeeper, Bookkeeping, Cashflow Forecast, Due Diligence, Equity, Liabilities, People, Projections, Risk
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