The term due diligence has been in use since the mid-fifteenth century, and the meaning of the same is 'requisite effort'. Now, due diligence has taken an essential role in acquiring a company or starting a business. The legal meaning of the term is " taking reasonable care to avoid a loss to any person or their property". Therefore in layman language, the meaning of the same is 'to take care'. Due diligence plays an important part in calculating the status of a business or company by analyzing the working of the same. It is one of the most important processes to determine whether the company is in a profitable business or not.
Due diligence has different types and benefits of applying the same in different fields. In this blog, we will be informing you about due diligence; it's benefits and how it affects the working of a company. As it is imperative, people are generally advised to perform due diligence before buying a shop, acquiring a business or even before buying a house.
Due Diligence: Definition
The basic meaning of due diligence is a process of investigation into the assets, liabilities, profits and losses of a company or business a person is looking to buy. Any person with knowledge of doing business will perform due diligence before the final transaction is done in order to verify the worth of the same business. Due diligence is a concept based on 'Caveat Emptor' which means 'buyer beware'. It is a process to ensure that the buyer doesn't buy or acquire a business without realizing all the important factors affecting the same business.
When due diligence is performed, the key factors to be looked at are profits, financial risk, legal issues, deal-breakers etc. of a business. A person authorized or hired for the same goes through the history of transactions and profitability of a company while performing the same.
Due diligence usually means scrutinizing the annual reports, SEC filings and looking at all the information about the securities of a company. The aim of due diligence is to examine the relevant facts about the company or business before buying it, in order to avoid losses and to understand the scope of profitability in the same business. It does not only include examining the annual reports, but the auditor can also go and talk to the employees to find out if the company is in a good state or not.
Types of Due Diligence
There are many kinds of due diligence, and they have been discussed below.
1.FINANCIAL DUE DILIGENCE- It is also known as the accounting due diligence as it looks into the economic and financial situation of the company. While performing financial due diligence, a person looks at the consistency among the assets and liabilities and also in the accounts.
2. LEGAL DUE DILIGENCE- This due diligence is all about studying the legal contracts of a company to understand if there is any hidden loophole or lawsuit against the company.
3.OPERATIONAL DUE DILIGENCE- As the name suggests, it means examining the operations of the company, including the competition, business model, and how it works in the market.
4.PRODUCT DUE DILIGENCE- This informs a person about the product with which the company is dealing. It includes the sale of the product, how profitable is the sale, how is that product made etc.
5.HUMAN CAPITAL DUE DILIGENCE- It involves interacting with the employees, staff and other people in the company to understand the working and the status of the company. This gives the buyer a clearer idea of how stable the company is and also about the work environment.
Benefits of Due Diligence while Acquiring a Business
There are a lot of benefits of performing due diligence, and some of them are discussed below.
- The most important benefit of performing due diligence is to prevent losses or fraud. Before acquiring a business, if due diligence is performed, then the person will have knowledge about the business, and he will be able to figure out if acquiring the same is profitable or not.
- Another benefit of due diligence is that while going through the legal contracts, a person can find out about the hidden factors of that company and can be more cautious before getting into the final transaction.
- Due diligence also helps improve the reputation of the company in the market as it helps to clear the status of the company.
Due Diligence Practices for Profitability
To take your companies towards the path of profitability, a person should be guided towards company due diligence in order to understand the practices. There are some due diligence practices which have been discussed here.
- Looking and examining financial statements helps to understand the status of the company, which further help you to figure out the ways to earn the profit.
- Evaluating the debts and liabilities will make your company know it’s own value and help you to work towards progress.
- Knowing about the market trends and what is going on in the market will also help you grow and earn the profit.
- Knowing about the competitor is another important aspect of progress.
- Evaluating what customers want is also an important factor in boosting up the sales, which will help in gaining profits.
Due diligence is an important factor in the growth of the company. It is important for every business to perform due diligence time to time, and as it is a long and time-consuming process, it is important to hire someone who is a professional for the same. Here in JAXA, we provide you with all kinds of accounting services and if you need help and assistance of any kind, feel free to contact us.