Due diligence checklist: the financials buyers want to see

A due diligence checklist for the financial side of a sale lists what a buyer will ask to see before closing: monthly and annual financial statements, the general ledger, revenue by customer, an EBITDA adjustment schedule with support, bank statements, monthly net working capital, debt and debt-like items, payroll, tax filings and the forecast. The buyer uses each document to test one thing: whether the earnings, cash and liabilities behind the price are what the seller says they are.

This checklist is for owners and founders preparing to sell, and for their finance teams. It covers financial diligence only; legal, commercial and technology diligence run alongside it. How the earnings themselves get tested is covered in the guide to quality of earnings and EBITDA adjustments.

When financial due diligence happens

Financial due diligence usually starts in earnest after a letter of intent is signed, inside an exclusivity period of a few weeks to a few months. The buyer, often with an accounting firm running a buy-side quality of earnings review, sends a request list and works through it against a deadline.

The SBA advises sellers to decide how much access the buyer will have to the company's information before closing, and not to leave any assets or liabilities out of the sale agreement. Both points start here: what the buyer finds in diligence shapes what ends up in the purchase agreement. Where diligence sits in the whole sale, from preparing the numbers to closing, is set out in the guide to selling a business.

The financial due diligence checklist

The table groups the usual requests into ten areas, with what the buyer is testing in each.

Revenue timing deserves particular care. Revenue is recognized as the promised goods or services are delivered, not when they are invoiced, so annual contracts billed upfront are one of the first places a buyer looks for overstated recent results.

The requests that take longest

Most of the list is exported from the accounting system. The requests that take sellers longest are usually the ones that have to be rebuilt:

• Monthly net working capital history. Many companies have never measured it monthly. It sets the working capital peg, so a seller without it negotiates from the buyer's first draft.
• Revenue by customer, tied to the books. A customer list from the billing system that does not reconcile to recognized revenue in the ledger triggers a round of questions on its own.
• Support for each EBITDA adjustment. An adjustment without an invoice, a contract or a payroll record behind it is usually cut.
• A complete list of debt-like items. Accrued bonuses, deferred payroll taxes and customer deposits are easy to miss and are deducted from the price.

An illustrative request tracker

Keeping one tracker that both sides can see avoids duplicate requests and lost answers. A simple version looks like this:

Illustrative example, not client data.

Numbering requests by area, as above, makes it easy to point the buyer to the exact document and keeps follow-up questions attached to the original request.

How to prepare before the letter of intent

The goal is that the buyer finds what the seller already found and explained. In order:

1. Close the books monthly, on an accrual basis. Diligence runs on monthly data. Cash basis or quarterly books force a rebuild under deadline.
2. Reconcile everything to the ledger. Every figure in the marketing materials, from revenue to adjusted EBITDA, should trace to the general ledger, because the buyer will rebuild it from there.
3. Build the adjustment schedule with support. Include the negative adjustments, such as below-market owner pay or a vacant role. A schedule that cuts both ways is more credible.
4. Measure monthly net working capital for at least 12 to 24 months, with notes on seasonality.
5. List debt-like items and related-party arrangements, and decide how each will be handled at closing.
6. Collect tax filings and notices for income, sales and payroll taxes, and resolve open notices before going to market.
7. Set up the data room with folders numbered to match the checklist areas, so each request maps to one place.

Tax structure matters as early as this list. The IRS explains that the sale of a business is usually not the sale of one asset: each asset is generally treated as sold separately when working out gain or loss, and buyer and seller both use the residual method to allocate the price. How the price is allocated affects the seller's tax, so bring the company's tax adviser in before terms are agreed.

Gaps that slow a deal down

These are rarely dramatic. Each one, found late, costs price, time or trust:

• Monthly results that do not add up to the annual statements, because of late adjustments posted only at year end.
• Revenue recognized when invoiced rather than when earned.
• Customer concentration that was not disclosed upfront.
• Figures in the marketing materials that differ from the ledger with no reconciliation.
• Slow answers. A request that takes two weeks suggests the numbers are held together by attention rather than process, and buyers price that in.

A seller's finance team, or a fractional CFO with diligence experience, can work through this list in the months before a sale so the buyer's review becomes a confirmation rather than a renegotiation. Decipher's Strategic Projects include sell-side readiness and support through diligence.