Financial Due Diligence: What Buyers Check and How to Prepare

Financial due diligence is the investigation a buyer or investor carries out on a company's financial information before closing a deal. It tests whether the earnings, cash flow, working capital and debt the seller has presented are real and repeatable. The result is usually a quality of earnings (QoE) report, which restates the company's EBITDA to a figure the buyer is willing to pay a multiple on.

Diligence findings are the most common reason signed deals fall apart. In Axial's analysis of 75 Axial-sourced transactions that broke after a letter of intent in 2025, 25.3% failed on diligence findings outside the quality of earnings and another 21.3% on QoE EBITDA discrepancies. Together, that is nearly half of all broken deals.

This guide covers what financial due diligence tests, how a QoE changes the number, how the working capital peg works, and what to prepare before a buyer asks.

What is financial due diligence?

Financial due diligence is part of the wider due diligence on a transaction, alongside legal, tax, commercial and technology reviews. Its scope is set by whoever commissions it, usually the buyer, and it typically covers five questions:

1. Are the earnings real? Revenue and costs are tied back to contracts, invoices and bank statements.
2. Are they repeatable? One-off items are removed, and costs the owner has kept off the books are added back in.
3. How much working capital does the business need? This sets the "peg" that the purchase price is adjusted against at closing.
4. What counts as debt? Bank loans, plus liabilities that behave like debt, all reduce what the seller receives.
5. Does the forecast hold up? The historical trend is compared with the plan the seller is marketing.

There are two sides to it:

• Buy-side due diligence is commissioned by the buyer, after the letter of intent, to test the seller's numbers.
• Sell-side due diligence (called vendor due diligence in the UK and Europe) is commissioned by the seller before going to market, so problems surface while the seller still controls the timing and the story.

Financial due diligence vs. an audit

A clean audit does not mean a clean diligence. The two answer different questions.

A company can pass its audit and still see its EBITDA cut in diligence. The accounting can be correct while the earnings are not repeatable. Many smaller companies also have unaudited accounts, and diligence catches the accounting errors in them, as two of the adjustments in the example below show.

What a quality of earnings report covers

A quality of earnings report is the core deliverable of financial due diligence. It is usually prepared by an independent accounting firm. Its purpose is to move from the EBITDA in the accounts to normalized EBITDA, the earnings a buyer believes the business will keep producing under new ownership.

A typical QoE covers:

• EBITDA adjustments: one-off, non-operating and owner-related items, each supported by evidence
• Revenue quality: recognition timing, customer concentration, churn, pricing and contract terms
• Proof of cash: reported revenue and expenses reconciled to actual bank deposits and payments
• Net working capital: monthly trend, seasonality and a proposed peg
• Net debt and debt-like items: anything the buyer will deduct from the price
• Run-rate and pro forma items: for example, the full-year effect of a price increase or a new hire

Proof of cash is the test founders tend to underestimate. It reconciles what the income statement says with what actually went through the bank. Timing gaps, unrecorded refunds and cash movements missing from the books all show up here.

Worked example: how adjustments change the price

A company reports $2.40 million of EBITDA. Management presents adjusted EBITDA of $2.76 million, with three add-backs. The buyer's QoE accepts two of them, rejects one and finds three adjustments of its own.

Diligence-adjusted EBITDA is $2.30 million, not $2.76 million, which is 16.7% lower. At an illustrative multiple of 7x, the headline price falls from $19.32 million to $16.10 million. That is $3.22 million less, before any change to the multiple itself.

Three things decide how that conversation goes:

1. Evidence. An add-back without documents is a negotiation the seller usually loses.
2. Consistency. A cost that recurs every year is not one-off, whatever it is called.
3. Symmetry. Buyers find downward adjustments too. A seller who only presents add-backs loses credibility on all of them.

Net working capital and the peg

Most buyers acquire a business cash-free and debt-free, with a "normal" level of working capital left in it. That normal level is the working capital peg. It is usually based on the average of the trailing twelve months, to smooth out seasonality. If working capital delivered at closing is below the peg, the price goes down dollar for dollar. If it is above, the price goes up.

These adjustments are now standard. SRS Acquiom's study of more than 1,500 private-target acquisitions found working capital adjustments in more than 90% of transactions, up from 50% a decade earlier.

Continuing the example:

The shortfall often has an innocent cause: a closing date that falls in a seasonal low, or a working capital definition that picks up accruals the monthly accounts never booked. Chasing receivables before closing doesn't help either. In a cash-free, debt-free deal the seller keeps the extra cash, but working capital falls by the same amount, so the price falls with it. Agree on the definition of working capital, and the accounts inside it, early.

Most deals with an adjustment also hold back part of the price to cover it. In SRS Acquiom's 2025 study of 1,250 private-target deals closed from 2020 to the third quarter of 2024, 75% of deals with a purchase price adjustment had a separate escrow for it. The median escrow was around 1% of transaction value.

Net debt and debt-like items

Buyers deduct net debt from enterprise value. The argument is usually about what else counts as debt. Items commonly raised in diligence include:

• Accrued but unpaid bonuses and commissions
• Taxes owed for periods before closing
• Customer deposits and, in some deals, deferred revenue (which is otherwise usually treated as part of working capital)
• Deferred capital spending that the new owner will have to make up
• Earn-outs or deferred payments owed from the company's own past acquisitions
• Lease obligations, depending on how the agreement defines debt

Each of these reduces the equity value dollar for dollar if the buyer wins the point. Deferred revenue is the most contested. It is a liability on the balance sheet, but the cost of delivering the service is often far smaller than the cash received.

The financial due diligence process

1. Letter of intent and exclusivity. Price is agreed "subject to diligence", usually as a multiple of an EBITDA figure the seller has presented.
2. Data request. The buyer's advisors send a request list, typically running to dozens or hundreds of items.
3. Data room and management sessions. Documents are uploaded, and management answers questions about them.
4. Analysis. The buyer's advisors build the QoE, proof of cash, working capital and net debt analysis.
5. Findings and renegotiation. Adjusted EBITDA, the peg and debt-like items feed into a revised price, escrow and contract protections.
6. Closing and true-up. Working capital and net debt are estimated at closing, then trued up in the months after.

How long it takes depends on the company's readiness far more than on its size. In SRS Acquiom's 2026 survey of 150 senior executives at U.S. investment banks, one in five said due diligence timelines had lengthened over the past two years. Of those, 57% said the extension was one to three months. In Axial's data on deals that broke after the letter of intent, exclusivity had run from about a month to more than five months on average, depending on the type of buyer.

Why deals break in financial due diligence

Axial's Dead Deal Report on 2025 deals analyzed 75 Axial-sourced transactions that failed after a letter of intent:

The six most common reasons. Together they cover 93.3% of the failed deals.

The damage usually comes from surprise: the buyer finds something the seller should have disclosed, and trust in every other number goes with it. The renegotiation failures in the third row are often the same problem one step later.

Financial due diligence checklist

Have these ready, reconciled to each other, before a buyer asks:

How to prepare as a seller

1. Close the books monthly and on time. Buyers diligence monthly numbers. A year-end-only close leaves months nobody can explain.
2. Run your own adjustments first. List every add-back you intend to claim, with evidence, and look just as hard for the downward ones a buyer will find.
3. Reconcile revenue to cash. Do your own proof of cash before a buyer does.
4. Understand your working capital. Know your monthly net working capital and its seasonal pattern before a peg is proposed.
5. Consider a sell-side QoE. For a larger or more complex company, a QoE commissioned by the seller surfaces issues early and gives buyers a report to start from. Buyers usually still do their own.
6. Align the forecast with the history. A plan that breaks sharply from the trend needs drivers that explain why.

This is the substance of exit readiness: the work is done months before a sale, not during exclusivity. It is also the evidence base for a defensible business valuation.