What is due diligence - Definition, Examples, process

Hi guys. In this article I am going to cover due diligence, what are the goals of due diligence, about their types and examples. I will be very specific to this topics and try to make you understand this term very easily.

What is Due Diligence?

Due diligence is an evaluation of a company often done during an acquisition, merger or before issuing IPO by considering some facts. Some people confuse Due Diligence with Audit. Both of the terms are not same. We are going to learn about it in this article.

Audit vs Due Diligence:

Some people mix the term Due Diligence with Audit but due diligence is more than that. Due diligence is very similar to audit but it is not audit.

1. Due Diligence doesn't always have to follow accounting rules.
2. You must follow accounting rules or GAAP for auditing.

Goals of Due Diligence:

• To make sure that financial, business process and operational details to look right.
• To look for inconsistency in best practices of business operation, anything factually wrong and any manipulation for showing the financial condition of a business looks good.

Due Diligence Example:

When you buy a car, you ask some question before the purchase. Am I right? Similarly before purchasing shares of a company,  you will surely ask some questions. You will ask how much profit did this company earned last year. You will ask how much Liability do they have. You will ask how much asset did their company increased. You will definitely look for the ethical record of the company. Everything you do to evaluate this company is due diligence. 

Who Engages in Due Diligence:

1. Who Acquires a Corporation:

When a firm buys another. The buyer evaluate the profit/ loss, liability and asset of a company to determine if the company will be profitable for them in the near future.

2. Mergers:

When two companies marge into one, they evaluate both of their capacity. For example: American Airlines and US Airways merged into one. They evaluated if the deal would be good or bad. They did this by due diligence.

3. Private Equity Firms:

Private equity firm invest in company. They often buys company who are distressed or losing money.
They want to be sure that this company will be profitable in future.

4. Banks:

When a bank give loan to a company or issue bond for a company or help the company go public, you can be sure that that bank performed due diligence before their action.

5. Consultancy Firms:

They help other four parties above to perform their actions.

Due Diligence Process:

You are going to have to follow some steps to perform due diligence.  Such as you need to check the balance sheet, the company record, paper of land or asset, future potential of the company etc. If you need the know details about due diligence process you need to read my article about it. Click this link to know about due diligence process or checklist.

This is all for today. Thank you.
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