Due Diligence (DD): What is it and Why is it Important?

Due Diligence Audit in Business greentick

Introduction : Due Diligence

The Due diligence (DD) is a complete and appropriate review of documentation and facts in Business audit. These facts and documents can include items like analyzing all financial records, past company performance, plus anything else considered information. It is a universally used term across multiple disciplines, particularly in the legal and corporate realms. From the business point of view, it refers to the investigation performed by an interested party; such as venture capital and private equity firms, that wants to merge or acquire a target company.


Apart from that, due diligence is applied in many other contexts, for example, conducting a background check on a potential employee or reading product reviews. Many experts agree and believe that due diligence is a systematic way to analyze and mitigate risk from a business or investment decision. As an investor or a company, one should consider various factors when performing due diligence on a business, including company capitalization, revenue, valuations, competitors, management, legal, commercial, and risks.


Types of Due Diligence in Business Audit

There are various types of due diligence depending upon an extensive process undertaken by the investor or a business. Some of the essential due diligence is discussed below:


Finance Due Diligence:
Finance due diligence is performed to ensure that the provided financial documents and information are accurate. It provides a deep understanding of all the audited financial statements generally for the last three years. Furthermore, investors or businesses can also assess the recent provisional financial statements with comparable data, projections, capital expenditure plan, schedule of inventory, debtors, and creditors.


Administrative Due Diligence:
This due diligence is performed when an investor or a business wants to thoroughly know about administration-related items such as facilities and workstations, etc. Besides, it also provides a better understanding of the operational costs that are likely to be incurred while working with or acquiring the company. It also analyzes the target company’s systems and processes to identify further risks arising from the execution of the business function.


Human Resources Due Diligence:
Unlike other due diligence, human resource due diligence is very extensive. It considers the complete analysis of the total employees, designations, vacancies, due of retirement, and serving the notice period. Not only that, the analysis of current salaries, bonuses paid generally during the last three years, and years of service is also equally important. In addition to this, HR policies regarding annual leave, sick leave, employee problems, employee health benefits, and welfare insurance is even likely to fall under this due diligence.


Legal Due Diligence:
One of the extremely important DD is legal due diligence. It includes the analysis and review of the Memorandum of Association (MoA) and Articles of Association (AoA). At the same time, this due diligence will also go through all the minutes of board meetings generally for the last three years, share certificates, contracts like a joint venture or partnership agreements, and many more.


Tax Due Diligence:
This due diligence is performed to review all taxes the company is required to pay. It will ensure that there is a proper calculation of taxes and no purpose of under-reporting. It usually focuses on copies of all tax returns that include income and non-income taxes such as sales/purchase, employment payroll, property transfer, and many more. Tax examination is highly underlined area of this due diligence as it prevents investor or business from tax liabilities and tax errors, which are considered as the most common risks.


Physical Asset Due Diligence:
Physical asset due diligence is conducted to examine the detailed schedule of the fixed assets and their location. Moreover, it also includes analysis of sales and purchase of the major equipment, any lease agreements or disposal in the last three to five years. In a general perspective, it assists the investor or a business to identify and verify assets possessed by the company and their actual value.


Customer Relationship Due Diligence:
This due diligence perform to identify and have a close look at the target customer base. It’s analysis depends on purchases from these customers from the company. Besides, this DD also examines the service agreements, current credit policies, account receivables, customer satisfaction, and major customers lost within the last three to five years.


Vendor Relationship Due Diligence:
The vendor relationship’s due diligence can be almost as important as the customer relationship’s due diligence. The investor or a business needs to discover how well key vendors have been performing; in terms of on-time delivery, product quality, return policies, and willingness to resolve problems. Meanwhile, a financially weak vendor has the possible chance to cause serious problems for a company. Thus, the due diligence analyst needs to conduct a financial analysis of important vendors under this due diligence.


The Importance of Due Diligence Audit in Business

Each due diligence audit has its purpose and importance. It is also an essential element to a successful commercial transaction. For example, financial due diligence has its importance as it allows the investor or a business to assess all financial aspects of a potential acquisition to determine what the benefits, liabilities, risks, and opportunities are. Similarly, business due diligence involves a review and understanding of the customer and supplier contacts, work in progress, the status of receivables, employee relations, banking relations, etc.


In addition, due diligence can identify any matters that could be a potential deal-breaker. It can identify any issues with the business that may be able to cover up before settlement, for example, unregistered leases. Apart from that, it also allows the buyer or investor to renegotiate the terms of the deal to a more suitable price where issues have been identified. In the context of Nepal, due diligence audit has played an important role.


Basis of Audit

Both private and public organizations do conduct various types of due diligence audit. They are mostly based on the valuation process, merger & acquisition, private equity, and for any tax or legal issues. For example, in 2018, the Tourism ministry directed Nepal Airline Corporation (NAC) to conduct a due diligence audit. The main purpose of the DD was that it would allow them to ascertain the actual financial status of the corporation before going for a strategic divestment in the “immediate near future”. Likewise, due diligence has also played an important role in the Nepalese financial sector.


According to the provision of Merger Bylaws laid by Nepal Rastra Bank (NRB), financial institutions must complete their DD within six months after receiving a Letter of Intent (LOI) from the central bank. So, the due diligence audit is in well-consideration in Nepal. Generally, due diligence period is typically two weeks to one month in length; but can vary depending on the complexity of the transaction and can also extend further in some circumstances. Furthermore, due diligence is equally important when performing the following actions:


Mergers And Acquisitions:
From perspective of seller, as well as buyer, performing due diligence is extremely important when going for merger and acquisition. As a buyer, the investor can assess the financials, litigation, patents, and a whole range of relevant information. At the same time, seller can analyze experience of buyer, financial abilities to complete transaction, and ability to fulfill responsibilities. Moreover, from a seller’s viewpoint, due diligence can facilitate them to understand true value and integrity of their own business. This is extremely important as an owner, specifically an owner that wants to sell. Thus, due diligence plays a key role while undertaking important mergers and acquisitions.


When a particular organization is looking for a partnership with a vendor or a supplier; due diligence can further perform for analyzing the necessary alliances, necessary connections, business combinations, and such other alliances. The reliability of the company is a subject of concern when a company joins hands with each other. DD can assist to analyze vendor or supplier’s willingness to provide favorable prices, convenient delivery schedules, and generous payment terms. Hence, due diligence has an important role during partnership formation between organizations.



Gaining perceptive, timely feedback on quality and accuracy of facts and material information is the foundation of good decision-making process. Whether it is about establishing a new business relationship or partnership with a customer or third party; merger/acquisition, or even about money laundering; due diligence has its usage as it provides information based on facts. Therefore, it is equally important for any investor, business, or organization.