(M&A UPDATE) How Financial Due Diligence Different From Audit

(M&A UPDATE) How Financial Due Diligence Different From Audit

When you buy a company, you’re not just buying its brand, customers, or factory. You’re also buying its hidden financial problems. That’s why financial due diligence is not a luxury … it’s a must.

Many SME bosses think: “Why waste money on checking when the seller already gave audited accounts?”
The truth is simple: audits are not designed to protect you as a buyer. Due diligence is.

What Is Financial Due Diligence?

Financial due diligence (FDD) is a systematic review of the seller’s financial health. It digs deeper than normal audits and management accounts to uncover issues that could affect your decision, valuation, and future headaches.

Here’s a structured look at the key FDD steps that matter most in a Malaysian acquisition.

1. Preliminary Assessment : Setting the Stage

Before diving deep, the process begins with a high-level scan. This involves gathering publicly available data such as audited accounts, company profiles, and news reports. The goal here is not only to form an initial impression of the business but also to prepare a working checklist and a rough valuation range. Think of it as setting a baseline before investing time and money into the detailed review.

2. Detailed Financial Review : Looking Beyond the Numbers

Next comes a full review of the company’s financial statements—balance sheet, income statement, and cash flow. The review also covers classifications of assets and liabilities. Here, the spotlight is on off-balance sheet items (such as hidden guarantees), operating expenses, and retained earnings. The focus is not just whether the numbers add up, but whether they reflect the true financial position of the business.

3. Tax Compliance Review : No Surprises from LHDN

In Malaysia, tax exposures can derail a deal. FDD therefore includes a detailed check on tax filings, credits, liabilities, and any past or ongoing disputes with LHDN. This step helps buyers avoid inheriting unpaid taxes, penalties, or aggressive tax positions that might later invite audits.

4. Earnings Quality : Testing the Stability of Profits

Headline profit numbers are not enough. FDD drills into revenue sources, gross and net profit margins, working capital cycles, and EBITDA. Buyers want to know: Are earnings consistent and sustainable? Are they driven by core operations or one-off items? For SMEs, this analysis often reveals whether growth claims are real or inflated.

5. Capital Structure Check : Understanding Who Owns What

The capital structure review focuses on equity ownership, debt obligations, and dividend history. Particular attention is paid to unusual financial instruments or debt covenants that could restrict business decisions after the acquisition. This step ensures that buyers know exactly what financial commitments they are walking into.

6. Review of Financial Policies : Consistency Matters

Accounting practices can vary widely among Malaysian companies. FDD reviews revenue recognition, cost capitalization, and internal controls to ensure they are applied consistently and fairly. Any aggressive accounting practices—such as recognizing revenue too early—can be a red flag for future earnings restatements.

7. Identifying Red Flags : Spotting the Hidden Dangers

The real value of FDD lies in identifying risks that the seller may not highlight. Common red flags include:

  • Aggressive revenue recognition methods

  • Aging receivables and doubtful debts

  • High dependence on a few key customers

  • Overstated asset values

  • Excessive management compensation

  • Related-party transactions that drain resources

These issues don’t always kill a deal, but they do impact valuation and negotiation.

8. Assessment and Reporting : The Decision Tool

Finally, the findings are summarized in a due diligence report. This includes a risk assessment, quantified financial exposures, and recommendations on deal adjustments. Buyers often use this report to negotiate lower purchase prices, request warranties, or structure escrow provisions to protect themselves.

Why This Matters for SME Buyers

In Malaysian M&A, due diligence is more than a compliance box—it’s an insurance policy. For SME buyers, the risks of hidden tax liabilities, inflated earnings, or disguised debts can be catastrophic. A systematic due diligence process reduces these risks and gives confidence that the investment is sound.

Closing Thought

Every acquisition is a leap of faith. Financial due diligence doesn’t eliminate the risks, but it makes sure you know what you’re jumping into. For SMEs, this clarity is not just helpful—it’s essential to making the right deal at the right price.

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