In every business transaction—whether it involves investments, mergers and acquisitions, or strategic partnerships- gaining a comprehensive understanding of a company’s financial position is essential. Financial Due Diligence (FDD) ensures that all information used for decision-making is accurate, complete, and reflective of the company’s true operational reality.

Through this process, companies can identify potential risks, assess the quality of earnings, and evaluate the target business's long-term financial sustainability. FDD also provides clear insights into cash flow stability, compliance, and financial obligations that may not be fully disclosed.

What Is Financial Due Diligence?

Financial Due Diligence is the process of evaluating a company’s financial health through an in-depth review of financial statements, cash flows, capital structure, potential liabilities, and performance-driving factors.

The core objectives of FDD are to:

• Determine whether the presented financial information is valid and reliable.
• Identify hidden financial risks that may not appear in standard financial reports.
• Provide a strong basis for valuation and transaction strategy.

In acquisition or investment transactions, FDD is a crucial tool to ensure there are no financial surprises after the deal closes.

Scope of Financial Due Diligence

Generally, an FDD review covers several key areas:

1.      Quality of Earnings (QoE) and Profitability Consistency

This includes analyzing earnings over several years (typically the last three years). The goal is not only to assess reported EBITDA or net income, but also to understand the sustainability of earnings and how well they translate into cash.

2.      Cash Flow Analysis and Liquidity

Cash flow reveals the company’s real ability to service debt, fund growth, and generate returns for shareholders. The analysis focuses on operating cash flow, working capital requirements, and overall liquidity.

3.      Capital Structure and Leverage

This includes reviewing debt composition, leverage levels, and potential future obligations. A key part of FDD is identifying liabilities—both recorded and unrecorded—that may trigger purchase price adjustments or require indemnity clauses in the share purchase agreement.

4.      Evaluation of Assets and Liabilities

This covers the review of accounts receivable, including an aging analysis to identify overdue or doubtful accounts and an assessment of the adequacy of bad-debt provisions. The assessment also includes potential hidden liabilities, off-balance-sheet items, and other financial exposures.

5.      Tax Review

The tax assessment includes compliance history, tax impacts on earnings, potential deferred tax liabilities, and risks related to tax audits. This helps investors anticipate potential tax burdens that may affect valuation.

6.      Review of Business Trends and Key Performance Drivers

This involves comparing the company with industry peers and analyzing macro- and micro-economic factors. The review evaluates revenue trends, changes in the cost structure, shifts in consumer behavior, and competitive dynamics. External factors—such as regulation, economic conditions, inflation, interest rates, and technological developments—are also considered.
 A comprehensive trend analysis helps investors determine whether the company is on a sustainable growth path and anticipate risks that may affect future performance.

Conclusion

Financial Due Diligence is a critical process that ensures transparency and minimizes risk in business transactions. By gaining a complete understanding of a company’s financial condition, investors can make more informed decisions, accurately determine valuations, and uncover risks that may not be apparent in standard financial statements.

In today’s competitive investment and M&A landscape, FDD is a foundational element of safe, strategic business decisions. With the growing M&A and investment activities in Indonesia, the need for a comprehensive and reliable FDD is becoming increasingly important to support sound decision-making.

"Make informed transaction decisions by starting with Financial Due Diligence"

Contributor: Selvy Evelina
Sandiva | Financial Advisor