Revenue quality
Customer concentration, recurring versus one-time sales, contracts, cancellations, seasonality, cut-off and post-period performance.
Buying a business
What should I check before buying a business?
Financial due diligence should verify what the business earns, how those earnings convert to cash, what obligations transfer, and how much funding the buyer will need after closing.
Short answerDo not stop at adjusted EBITDA. Reconcile revenue, margins, owner add-backs, working capital, tax and payroll exposure, debt-like items, capital spending and post-close cash requirements to source evidence.
The buyer's financial due diligence checklist
Gross margin
Product and customer mix, labour or subcontractor treatment, purchasing changes and margin trends hidden by averages.
Normalized earnings
Owner compensation, related parties, one-time items and add-backs supported by documents and replacement-cost assumptions.
Working capital
Receivable aging, bad debts, inventory quality, payables, deposits, accruals and the normal amount delivered at closing.
Liabilities and commitments
Loans, leases, taxes, payroll, warranties, litigation, capital commitments and other debt-like or contingent items.
Post-close cash
Transaction costs, buyer equity, debt service, deferred maintenance, hiring and the working capital needed after ownership changes.
Quality of earnings asks whether the profit will continue.
A useful review moves from the seller's reported earnings to buyer-maintainable earnings. Every adjustment should have a reason, supporting evidence and a view on whether it will recur under the buyer.
- Reconcile financial statements to tax, bank and operating records where relevant.
- Test revenue and expenses around period end.
- Compare add-backs with actual post-close replacement cost.
- Explain changes in working capital and cash conversion.
Illustrative earnings bridge
| Seller-reported EBITDA | $600,000 |
| Supported non-recurring add-backs | $40,000 |
| Replacement management cost | ($120,000) |
| Recurring deferred expenses | ($35,000) |
| Buyer-maintainable EBITDA | $485,000 |
Turn findings into deal decisions
A red flag does not automatically end a transaction. It may change how much the buyer should pay, the working-capital target, representations, holdbacks, financing or conditions to closing.
Coordinate professional scopes
Financial diligence does not replace legal, tax, environmental, operational or technical diligence. Material findings should be routed to the appropriate lawyer, accountant, lender or specialist.
Due diligence questions
What records should a buyer request?
Request financial statements, current results, tax and sales records where appropriate, bank information, receivables, payables, inventory, payroll, debt, leases, fixed assets, contracts and support for adjustments.
What is a quality of earnings review?
It tests whether earnings are sustainable by examining revenue, margins, expenses, working capital, cash conversion and unusual items.