Five questions to answer before you sign a deal

The price in a transaction rests on the numbers presented to the buyer. Financial due diligence is the process of testing those numbers before you commit. Whatever the size of the deal, five questions do most of the work.

1. How real are the earnings?

Reported profit is not always sustainable profit. Look for one-off gains or costs, revenue booked earlier than it should be, sales to related parties on unusual terms, and expenses that the current owner has been absorbing privately. The aim is to arrive at a view of normal, repeatable earnings, because that is what you are actually buying.

2. What debt, and what debt-like items, come with the business?

The headline price usually assumes the business comes free of debt. Check for borrowings, but also for items that behave like debt: unpaid taxes, overdue supplier balances, lease commitments, deferred payments to former owners, employee obligations and contingent liabilities. These reduce what the equity is worth.

3. Is working capital at a normal level?

Businesses preparing for a sale sometimes squeeze customers for early payment or delay paying suppliers, which flatters cash on the day of the deal. Compare working capital across the year, allowing for seasonality, to see what level the business really needs to operate.

4. Are tax positions clean?

If a company has underpaid tax, the exposure usually passes to the new owner along with the shares. Review returns, assessments, disputes and compliance history. Tax also shapes the structure of the deal itself: whether to buy shares or assets, and how to finance it, can change the after-tax outcome considerably, which is why tax structuring should start early.

5. Does the financial model hold up?

Projections in a sale document reflect the seller's optimism. Test the assumptions behind growth and margins, check how dependent revenue is on a few customers or contracts, and run sensitivities. If the deal only works under the most favourable assumptions, the price needs to reflect that.

Beyond the numbers

Financial findings are most useful when they flow into the deal: a change in price, an adjustment mechanism, specific warranties, or conditions to be met before completion. Legal due diligence should run alongside, covering ownership, contracts, licences and disputes. Afterwards, planning for the first months of integration protects the value you paid for.

Careful work on these five questions before signing is almost always cheaper than discovering the answers afterwards.