In business, a due diligence audit is basically a careful investigation into the complete financial picture of a company. Generally, these audits come before a purchase, merger or other major decision that could negatively influence the finances of one or more businesses. These audits are generally used to ensure that no hidden liabilities exist.
Due diligence can be compared to an employee background check on a corporate scale. Like perspective employees, companies wishing to be purchased are often trying to make the most positive impression possible. The strengths of the company are often highly stressed and the weakness is downplayed. A due diligence audit is the equivalent of checking references before hiring
In general, a due diligence audit focuses on information outside of what is freely presented. While it is generally expected for a purchasing company to perform these investigations, they are often done discreetly. The hire of private investigators is not uncommon, and seldom are the companies that are being investigated aware of the specific focuses of investigation.
Forensic accounting teams are often the backbone of a due diligence audit. These specialists are trained to thoroughly review the financial records of an organization for any discrepancies. Unlike traditional accountants, forensic accountants are specifically trained to search for fraud and hidden assets and debts.
The due diligence procedure involves: Identifying legal and financial risks associated with investing in a particular business
- Preparing a report on the legitimacy of a target business and its assets
- Advice on minimizing investment risks
The work which is performed within the due diligence procedure may be divided into three interconnected parts:
- Financial Due Diligence: confirmation of net assets, both title and value, check of accuracy of accounting, historic and prospective financial analysis, assessment of financial risks;
- Tax Due Diligence: check of accuracy of tax calculations, tax risks evaluation;
Legal Due Diligence: check of corporate structure, titles to assets, intellectual property rights, commercial liabilities and legal risks evaluation.
Effective Due Diligence depends on identifying and managing significant transaction issues, anticipating and identifying potentially important risk and negotiation issues. The objective is to improve future performance of the organization by forecasting of potential risk outcomes and attempting to improve the efficiency and effectiveness of the existing business processes.