Financial due diligence is a time-bound, scoped review of a target's financial information, carried out for a buyer, investor or lender (buy-side) or commissioned by the seller (vendor due diligence). It tests the earnings, net debt, working capital and exposures that drive price, and it is not an audit: it expresses findings and adjustments, not an opinion on financial statements.
Facts checked: 10 October 2026. There is no single ICAI standard that prescribes a financial due diligence report, so the structure below reflects common practice. I checked the section 43B(h) MSME payment rule (deduction on payment basis for micro and small enterprise dues beyond the statutory period, not exceeding 45 days) against commentary and a Ministry of Finance reply as reported there; I could not read the Income-tax Act text or confirm the assessment-year mapping, so no year is stated. ICAI's SRS 4400 on agreed-upon procedures is described by ICAI-hosted material as consistent with the international standard, but I could not confirm its effective date. References to sections 185, 186 and 188 of the Companies Act, Ind AS 24 and Ind AS 37 are from my own knowledge.
Buy-side and sell-side
| Buy-side | Vendor due diligence | |
|---|---|---|
| Commissioned by | Buyer, investor or lender | Seller or its adviser |
| Purpose | Price, structure, protections | Speed up the sale, reduce surprises |
| Reliance | Addressed to the buyer | Reliance letters to bidders, on agreed terms |
| Bias risk | Findings drive price down | Perceived as seller-friendly; needs a neutral basis |
See also financial due diligence and vendor due diligence.
Scope: what is normally covered
| Workstream | Questions |
|---|---|
| Quality of earnings | What is the maintainable EBITDA after one-offs, owner costs and accounting policy differences? |
| Net debt and debt-like items | What claims rank ahead of equity: borrowings, deferred consideration, overdue statutory dues, employee benefits, capex creditors? |
| Net working capital | What is the normal level, and is the closing peg fair given seasonality? |
| Contingent liabilities | Disputed taxes, litigation, guarantees, warranties |
| Related parties | Transactions off market, balances, guarantees to or from promoters |
| Tax exposure | Income tax, transfer pricing, GST, TDS; open assessments |
| Compliance | GST returns and reconciliation, TDS deduction and deposit, statutory dues |
India-specific issues
- Tax litigation. Map every open demand and appeal by forum, amount and likelihood. Ind AS 37 treatment in the books may differ from what a buyer should price.
- GST and TDS. Reconcile returns to books, check ITC claims against supplier filings, look at TDS defaults and interest.
- MSME payables. Overdue dues to micro and small enterprises can bring a disallowance until paid, as well as interest exposure under the MSMED Act. Treat the overdue amount as a debt-like or tax item.
- FEMA. Check the timing and pricing of foreign investment, reporting filings and any overseas borrowing or remittance. Non-compliance is a regulatory exposure, so involve legal counsel.
- Companies Act. Loans and investments (sections 185 and 186), related party approvals (section 188), filing defaults and charge registration.
- Ind AS adjustments. Revenue recognition cut-off, expected credit loss, lease accounting and employee benefits often move earnings when moved to the buyer's policy.
Process
- Scoping call, red-flag areas and information request list.
- Engagement letter, confidentiality undertaking and data room access.
- Fieldwork: management accounts, trial balances, bank statements, tax files, management Q&A.
- Draft findings discussed with the client; factual accuracy check with management.
- Final report, with supporting schedules, and a purchase agreement support period.
Typical report structure
- Executive summary and key findings
- Basis of preparation, scope and limitations
- Quality of earnings and adjusted EBITDA bridge
- Net debt and debt-like items
- Net working capital
- Tax, legal and compliance exposures
- Appendices: schedules, data sources
Worked example: a quality-of-earnings adjustment
Invented facts: a target with reported EBITDA of ₹24.0 crore for the year ended 31 March 2027.
| Item | ₹ crore | Reason |
|---|---|---|
| Reported EBITDA | 24.0 | Management accounts |
| Add: one-off legal settlement | 1.2 | Non-recurring, documented |
| Add: promoter vehicle and family travel | 0.4 | Personal, not business |
| Less: revenue booked before delivery at year end | (1.8) | Cut-off error found on testing |
| Less: arm's-length rent on promoter-owned premises | (0.6) | Rent was below market |
| Less: unprovided doubtful debts | (0.9) | Ageing and post-year-end non-receipts |
| Adjusted EBITDA | 22.3 |
At an invented multiple of 8, the adjustments reduce enterprise value from ₹192 crore to ₹178.4 crore. Net debt adjustments, for example ₹3.5 crore of overdue MSME dues, would then be deducted separately.
Differences from audit and valuation
| Statutory audit | Financial due diligence | Valuation | |
|---|---|---|---|
| Objective | Opinion on financial statements | Findings for a transaction decision | Value or range of value |
| Materiality | Set for the opinion | Set for deal relevance, often lower | Not applicable |
| Output | Auditor's report | Findings report, no opinion | Valuation report |
| Period | Past year | Several years plus current trading | Forward looking |
For the wider landscape, see types of audit in India; if fraud indicators appear, forensic audit is a separate engagement.
Engagement terms, independence and confidentiality
- State the purpose, scope and period, and that no audit opinion is given.
- Use the information provided by management without independent verification except as stated; say so.
- Restrict use and reliance: the report is for the named party, with reliance letters for others only on agreed wording.
- Confirm independence for the firm's other relationships with the target or the buyer. A firm that audits the target should consider the conflict before accepting buy-side work for a bidder.
- Keep confidentiality: data room terms, need-to-know team, secure storage and return or destruction at the end.
- Where a report is in the form of agreed-upon procedures, the engagement terms should align with the relevant ICAI standard.
Frequently asked questions
What is the difference between financial due diligence and an audit?
An audit gives an opinion on financial statements. Due diligence tests specific matters for a transaction and reports findings and adjustments without an opinion.
What is a quality of earnings review?
It restates reported profit to a maintainable level by removing one-offs, correcting errors and aligning policies, and is the core of most financial due diligence.
What is vendor due diligence?
A report commissioned by the seller, shared with bidders, covering the same areas to speed up the process.
How long does financial due diligence take?
It depends on size and data quality; scoping the information request early is the main driver of timing.
What are debt-like items?
Obligations that a buyer would treat as debt in the price: overdue statutory dues, deferred consideration, accrued employee liabilities and overdue MSME payables, among others.
Who relies on the report?
Only the parties named in the engagement terms or reliance letter.
Related: financial due diligence, vendor due diligence and types of audit in India.
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