Financial due diligence when buying a small business: what it covers and what drives the scope

By the time you reach due diligence, you have usually agreed headline terms with the seller and spent time and money getting there. Financial due diligence is where those assumptions meet the evidence.

For a smaller acquisition it does not need to be a vast exercise. It does need to focus on the things that could change the price, the structure of the deal, or whether you want to proceed at all.

What financial due diligence is – and is not

Financial due diligence examines the target business's financial information to test the figures you are relying on: earnings, cash, working capital, debt and forecasts.

It is one strand of a wider process:

• legal due diligence – contracts, property, employment, disputes and the transaction documents – is carried out by your legal advisers;
• tax due diligence looks at the business's tax position and exposures, and may be a separate piece of work;
• commercial and operational checks – customers, market, people, systems – are often led by you as the buyer.

Good financial due diligence links to the others. For example, it can highlight matters your legal advisers may want to address in the sale agreement.

When it happens

Financial due diligence usually starts once Heads of Terms are agreed and, often, once the seller has granted a period of exclusivity. Starting too early can waste money on a deal that does not progress. Starting too late can leave too little time to act on what is found.

What it usually covers

The exact scope depends on the business and the deal. Typical areas include:

• Quality of earnings – whether reported profits reflect sustainable trading, and whether the adjustments in the sale documents hold up.
• Revenue – trends, customer concentration, contract terms, pricing, and how revenue is recognised.
• Margins and overheads – what drives profitability, and costs that may change under new ownership.
• Working capital – the level the business normally needs to trade, and how it moves through the year. This matters because many deals assume a "normal" level of working capital is left in the business at completion.
• Net debt and debt-like items – borrowings, leases, overdue liabilities, deferred income, customer deposits and similar items that may be deducted from the price.
• Cash conversion – how reliably profit turns into cash.
• Forecasts – whether the assumptions behind any forecast are reasonable, given past performance.
• Financial controls and information – how reliable the underlying records are.

How it is scaled for owner-managed businesses

A focused scope concentrates on the areas of highest risk identified at the earlier stages – often quality of earnings, working capital and debt-like items. A more comprehensive scope covers more areas in more depth, which may be appropriate for larger, more complex or higher-risk deals.

The scope should be agreed at the start, in writing, so you know what will and will not be covered.

What drives the scope and the cost

The cost of financial due diligence varies because the work varies. The main drivers are:

• size and complexity – the number of companies, sites, revenue streams and systems;
• quality and availability of information – well-kept records and up-to-date management accounts shorten the work considerably;
• the risks already identified – issues found in an earlier review usually need testing in detail;
• the timetable – a compressed timetable can mean more resource over a shorter period;
• separate lender requirements – if you are borrowing to fund the purchase, the lender may have its own information requirements, which are handled separately from your due diligence;
• access to the seller and their accountant – prompt answers keep the work moving.

Proplexo's due diligence prices are shown on our pricing page. The scope for a particular deal is agreed with you before the work starts.

How to keep it efficient

• Ask the seller to provide information in an organised data room, against an agreed request list.
• Share what you already know, including any earlier review, so the work does not repeat it.
• Agree early what level of issue matters for this deal, so time goes on what is important.
• Raise questions with the seller as they arise, rather than all at the end.

What you get, and how findings are used

The output should be a clear report in plain English: what was found, why it matters, and what it means for the deal.

Findings are typically used to:

• revisit the price – for example, if sustainable earnings are lower than presented, or debt-like items are higher;
• shape the structure – how much is paid at completion and how much is deferred, and how working capital or net debt adjustments are handled;
• inform the legal documents – your legal advisers decide how matters are addressed in the sale agreement, for example through warranties or specific protections;
• decide whether to proceed – occasionally the right answer is not to.

How Proplexo can help

Our Financial Due Diligence service is scaled to the size and risk of the deal. We agree the scope with you at the start, focus on the areas that matter most for this business and this deal, and report in plain English – working alongside your legal advisers.

If you are earlier in the process, an Acquisition Assessment can help shape your offer before due diligence begins.

This article is general information for owner-managed businesses, not advice on your circumstances.