Most acquisitions that unravel after the term sheet do so on the numbers, not the strategy: reported EBITDA that does not survive scrutiny, working capital that was quietly stretched, or debt-like items nobody mentioned. Financial due diligence is where those gaps surface, and the side that understands it earlier negotiates from strength.
What Financial Due Diligence Services Actually Cover
Financial due diligence is an independent review of a target’s historical financials, accounting policies, cash conversion and balance sheet, done to test whether the numbers presented in the information memorandum are reliable. It is different from a statutory audit. An audit gives an opinion on whether accounts present a true and fair view; diligence asks whether the earnings are sustainable and what the buyer is really paying for.
A typical scope for financial due diligence services in an Indian M&A transaction includes quality of earnings, net debt and debt-like items, net working capital, tax exposure, and a review of the financial projections. It sits alongside legal, tax and commercial diligence. For startup funding rounds, the focus is different; our startup due diligence checklist covers what venture investors verify. This article covers the acquisition side: control deals, mergers and buyouts of mid-size companies.
Quality of Earnings: The Heart of the Exercise
Quality of earnings (QoE) strips the reported profit down to the EBITDA a new owner can expect to repeat. Buyers value businesses on a multiple of that figure, so every rupee adjusted moves the price by the multiple.
Common QoE adjustments
- Non-recurring items: one-off income, litigation settlements, asset sale gains.
- Owner and related-party costs: promoter salaries, rent paid to group entities, personal expenses run through the company, normalised to market levels.
- Revenue recognition: early recognition, bill-and-hold arrangements, or revenue booked before delivery. Check consistency with Ind AS 115 where applicable.
- Capitalised costs: development or operating costs shifted to the balance sheet to lift profit.
- Pro forma changes: full-year effect of new contracts, closed units or price changes.
A seller who presents a clean, reconciled QoE before the buyer starts rarely loses value in renegotiation. A seller who does not usually does.
Net Working Capital and Net Debt: Where Price Actually Moves
Enterprise value converts to the price paid for shares through net debt and working capital adjustments, and this is where many deals are quietly repriced.
Net debt and debt-like items
Beyond bank borrowings, buyers look for items that behave like debt: overdue statutory dues (GST, TDS, PF), deferred consideration, employee liabilities such as gratuity and leave encashment, customer advances, contingent liabilities, and guarantees to group companies. Each one that the seller did not disclose becomes a price deduction.
Normalised working capital
The buyer and seller agree a target level of working capital, usually the trailing average, and the price adjusts at closing for any shortfall or excess. Watch for sellers stretching payables or accelerating collections just before closing; a monthly working capital trend over 24 to 36 months exposes this immediately.
Red Flags Buyers’ Diligence Teams Look For
Sellers should assume these will be found, because they are the first things a diligence team tests:
- Customer or supplier concentration: a large share of revenue or purchases from one or two parties.
- Cash flow that does not match profit: rising receivables or inventory with flat cash generation.
- Related-party dealings at non-market terms, a Companies Act disclosure matter as well as a valuation one.
- Statutory non-compliance: delayed GST or TDS deposits, unreconciled input credits, pending ROC filings. The Ministry of Corporate Affairs filing record is publicly checkable and is usually one of the first things reviewed.
- Aggressive or changing accounting policies, and frequent auditor changes.
- Projections disconnected from history: hockey-stick forecasts with no operational bridge.
None is automatically fatal. Each is a pricing or indemnity conversation, and the earlier it is raised, the cheaper it is to resolve.
Buy-Side vs Sell-Side (Vendor) Due Diligence
Buyers commission buy-side diligence to protect themselves. Sellers increasingly commission vendor due diligence before going to market: a pre-emptive review that finds and fixes issues, supports the asking price, and shortens the buyer’s process. For a promoter-led mid-size company, it often pays for itself by avoiding a late-stage price cut.
Valuation connects directly to this. Where a transaction needs a formal valuation, the professional required depends on the law: a Registered Valuer for Companies Act and IBC matters, a Merchant Banker for Income Tax Rule 11UA DCF valuations, and a SEBI-registered Merchant Banker or Chartered/Cost Accountant for FEMA pricing. Our guides on share valuation and FEMA valuation requirements set out which applies when.
How to Prepare: A Practical Sequence
- Months 6 to 3 before launch: reconcile management accounts to audited financials and GST returns; clean up related-party transactions.
- Months 3 to 1: build a monthly QoE bridge and working capital schedule; document accounting policies; clear overdue statutory dues.
- At launch: assemble a data room with a clear index, and a reconciled financial model. If you also need a funding or buyer-ready model, FinVal’s virtual CFO services team supports this finance clean-up.
Talk to FinVal Before the Buyer Does
FinVal Research & Consultancy is a boutique finance firm led by IBBI Registered Valuers, supporting founders, promoters and CFOs through transaction advisory, valuation and financial due diligence readiness. Not sure what your business is worth to a buyer? Try the free business valuation tool, or book a free consultation to review your numbers before the buyer does.