It's not uncommon to explain the difference between a quality of earnings report and an audit report. A financial statement audit offers assurance to the public about companies' financial statements being authentic and accurate. In contrast, the financial due diligence includes analytical procedures that look at the economic risk of a company regarding an M&A transaction.

The differences between financial audits and financial due diligence are below:

The Audit Reports:

- Are focused on balance sheets

- Align with the fiscal year or the business

- Are looking at net income

- Double-check that revenue and expenses get recorded in the correct

fiscal periods

- Look at the fiscal year-end and verifies the ending balances of the accounts listed on the balance sheet

The Due Diligence Report:

- Pays attention to the earning power of the company

- Evaluates the trailing twelve-month period of the company

- Concentrates on EBITDA and free-cash-flow

- Wants to know that revenue and expenses get recorded in the correct

fiscal period and that they are all necessary expenses for business


- Quality of work capital: Evaluates the working capital accounts over a

given period of time

- Quality of fixed assets: Analyzes the recorded fixed assets over a

specific time frame

- Looks at the historical capital expenditures and then categorizes those

purchases into replacement vs. growth purchases

- Quality of revenue or pricing: Looks at the company's revenue and

pricing strategy

- Analyzes the company's customer base

- Completes a proof of cash analysis

- Looks at the company's contribution margin and analyzes it

- Gets a better understanding of the seller's projections by performing a

revenue bridge analysis

If a buyer wants to make this type of investment, the list above is an excellent place to focus. Ultimately it is up to the buyer to identify any areas of concern and validate their investment assumptions. A financial due diligence report needs to provide useful information although we recommend that you always ask more questions.

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