TABLE OF CONTENTS The basic goal of financial due diligence is to develop a firm valuation and understand the short-term financial issues impacting the firm, which, when used in conjunction with the legal due diligence discussed later, will help develop a valuation or investment strategy related to a particular security within the capital structure. The output or work product of the financial due diligence process should be:
A financial analysis of recent historical information: How far back this analysis should go will depend on the circumstances. For longstanding businesses, particularly cyclical businesses, it can be useful to compile data for the last ten years in order to provide insight on the magnitude of cyclical fluctuations and whether there have been any systemic changes to the industry (e.g., if a competitor's strategy of outsourcing production to lower cost regions has resulted in margin compression). Multiperiod analyses can also aid in assessing long-term capital expenditure requirements. Often, when looking at just the last year or two of results of a firm experiencing financial distress, the reported amount of capital expenditures may be below the true needs of the business, since this can be one of the first areas of cost cutting. As a general rule, capital expenditures should equal or exceed depreciation charges. When a firm provides operating data on different segments, it should be analyzed in an effort to determine whether discrete components of the business can be sold, as well as the potential...
