Financial due diligence in India: a buyer's and seller's field guide.

The first five reds we test for.

1. What financial due diligence actually is.

Financial due diligence is the work that turns a target company's reported financials into a defensible view of what the buyer (or seller, or investor) is actually getting. It is not an audit; it does not produce an opinion on the financial statements. It is a structured investigation, run on a deal calendar, that surfaces the adjustments, risks and quality issues that change the price, the terms, or the decision to proceed.

A good FDD answers the question an acquirer is paying to have answered: would I want this business at this price, on these terms? A bad FDD answers a different question: can I produce a 300-page report that documents I looked at everything?

India-specific layers add to the work. The Companies Act, 2013, the Income Tax Act, 2025, GST law, FEMA, labour law and sector-specific regulation all have to be considered in the diligence frame. A target's reported EBITDA can look healthy until the FDD surfaces a transfer-pricing exposure, an unprovided contingent GST liability, or a related-party transaction outside the audit-committee approval matrix that the SPA's representations will not cover.

2. The four kinds of FDD.

The same investigative discipline produces four different deliverables depending on who the client is and what the deal needs.

• Buy-side FDD - performed for the acquirer or investor. Produces a quality-of-earnings report, working capital and net debt analyses, and a red-flag report that feeds directly into the SPA.
• Sell-side / Vendor DD - performed for the seller before the buyer is in the room. Produces a clean, defensible pack that pre-empts buyer-side objections and shortens the negotiation calendar.
• Focused / investigative DD - performed mid-deal or post-deal on a specific concern (revenue recognition, related-party leakage, a contingent liability, a forensic concern).
• Pre-IPO / pre-funding readiness - performed 12 to 18 months ahead of a fundraise or listing, to identify and remediate the financial-hygiene issues that would otherwise emerge in a buyer or banker's DD.

The skills are the same in all four; the deliverable, the audience and the timing differ.

3. Buy-side: QoE, working capital, net debt, red flags.

The buy-side FDD is the most familiar form, and the most demanding. Four work-products typically come out of it.

Quality of earnings (QoE)

The QoE is a rebuilding of the target's reported EBITDA on a normalised, comparable basis. The objective is to give the acquirer a maintainable EBITDA - the EBITDA that the business can actually deliver in a normal year, not the reported number that may contain one-time gains, classification choices, or accounting policy outliers.

Typical QoE adjustments:

• Non-recurring items. Sale of fixed assets, insurance settlements, one-off legal settlements, restructuring costs.
• Owner-related items. Promoter compensation above market, related-party transactions at non-market rates, personal expenses booked through the business.
• Accounting policy normalisation. Revenue recognition timing, capitalisation thresholds, provisioning conventions, inventory valuation methods - adjusted to a buyer-typical convention.
• Cut-off adjustments. Revenue or cost recognised in the wrong period, especially around the deal cut-off date.
• Out-of-period items. Costs that belong to the period under review but were posted later (or vice versa).

The QoE is documented in a bridge: reported EBITDA, plus and minus each adjustment with reasoning and evidence, equal to adjusted EBITDA. The acquirer uses this to compute the purchase price.

Working capital analysis

Most SPAs include a working-capital target. The buyer pays the agreed price assuming the business is delivered with a "normal" level of working capital; if the actual working capital at closing is below the target, the price reduces dollar-for-dollar (and vice versa). The working-capital analysis sets the target.

The standard method is a trailing 12-month average of net working capital, with adjustments for seasonality. Where the business has strong seasonality (think a manufacturer with festival peaks), a seasonally-adjusted average is used. Exclusions: cash, debt and debt-like items, and any non-operating working capital.

The analysis is detailed enough that the SPA can drop in the target number with confidence, and the closing-statement review can compute the actual against the same definition.

Net debt and debt-like items

The deal mechanics typically deliver the target on a "cash-free, debt-free" basis. The buyer pays the equity value (enterprise value minus net debt). The debate is on what counts as debt and what counts as debt-like.

True debt is easy: bank borrowings, term loans, debentures. Debt-like items are harder and routinely disputed:

• Unfunded pension or gratuity obligations. The accrued liability that the buyer will inherit.
• Long-term provisions that look like operating items but are actually deferred liabilities (warranties, litigation provisions).
• Customer advances that the buyer must deliver against.
• Tax exposures. Open assessments, pending appeals, transfer-pricing positions.
• Capex commitments for purchases the seller has committed to but not yet paid.
• Off-balance-sheet liabilities. Guarantees, comfort letters, performance bonds.

The FDD lists every item, classifies it, quantifies it, and proposes how it should be reflected in the deal. The SPA's "debt-like items" schedule is built from this list.

Red-flag report

The red-flag report captures the issues that change the deal beyond pure pricing - issues that touch the representations, indemnities or even the decision to proceed. Typical reds:

• Revenue recognition that does not survive a critical look (round-trip sales, bill-and-hold, undelivered services).
• Related-party transactions that bypass the audit-committee approval matrix.
• Unprovided contingent liabilities (GST exposures, customs duty disputes, labour litigation).
• Concentration risks (one customer above 30%, one supplier above 30%, one geography above 70%).
• Working-capital window-dressing in the period leading to deal cut-off.
• Indications of front-loading or back-loading of profitability.

Reds are ordered by severity, with the top three on the second page of the report so they are the first thing the acquirer reads after the executive summary.

4. Sell-side: the vendor DD pack.

A vendor due diligence pack is a buy-side-quality FDD performed before any buyer engages, and used by the seller to lead the negotiation rather than respond to it.

The pack typically contains:

• The seller's own QoE, with adjustments already identified and explained.
• The seller's working-capital analysis with a defended target.
• The seller's net debt and debt-like items list, with the seller's positions documented.
• A disclosures schedule that pre-empts the buyer's likely diligence questions.

The discipline is to give the buyer fewer things to find and to set the frame for the negotiation. A good vendor pack shortens diligence by weeks, narrows the negotiation to a small list of items the buyer can still legitimately push on, and gives the seller a defensible position on every line.

5. Focused / investigative DD.

Focused DD is engaged when a specific concern arises - typically mid-deal, occasionally post-deal. Common scopes:

• Revenue recognition in a particular segment, after the buyer's main DD raised a question.
• Related-party transaction history over a 36 to 60 month look-back.
• Capex versus opex classification, where the buyer suspects capex inflation of EBITDA.
• Inventory verification at a specific location.
• Cash-management practices in a specific subsidiary.

Focused DD is short and deep. Two weeks, one issue, one report. The deliverable is a memo, not a 200-page report.

6. Pre-IPO and pre-funding readiness.

Companies preparing for a listing or a major fundraise (Series C onward) increasingly run an FDD on themselves 12 to 18 months ahead of the transaction window. The objective is to identify what would otherwise be a buyer's, banker's or stock-exchange diligence finding, and remediate it before it appears in a public process.

Typical pre-IPO findings that benefit from early remediation:

• Related-party transactions that need to be transitioned to arm's length or unwound.
• Segment reporting that has not been set up.
• Inadequate disclosures in related-party schedules, AS 18 (or Ind AS 24) presentation.
• Internal-control gaps that would surface in the auditor's IFC opinion.
• Tax positions that need to be either clarified through advance ruling, provided for, or restructured.

The pre-IPO FDD becomes a 12-month remediation roadmap, with the listing or fundraise as the deadline.

7. The typical FDD calendar.

For a mid-sized target (₹100 to 500 Cr revenue), the buy-side FDD calendar is approximately:

• Week 1. Kick-off, document request list, data room access, management interview schedule.
• Week 2. Initial document review, first round of management questions, preliminary observations.
• Week 3. Detailed work-streams: QoE bridge, working capital, net debt, taxation, commercial, legal interface.
• Week 4. Draft red-flag report and detailed findings, second-round management interviews, draft circulated to deal team.
• (Week 5 / 6 if extended scope.) Final report, SPA-input memo, working-capital and debt-like-item schedules in SPA format.

Vendor DD typically takes 4 to 6 weeks because the seller has more time and the pack is more comprehensive. Pre-IPO readiness runs 6 to 8 weeks for the diagnostic, then 12 months for the remediation track.

8. What a deliverable that is actually useful looks like.

The buyer reads in this order: (a) the executive summary, (b) the top red flags, (c) the QoE bridge, (d) the working capital and net debt schedules, (e) selectively, the section relevant to the specific issue under negotiation. Almost nobody reads the report cover-to-cover.

A useful FDD report is therefore built around what the buyer will actually read:

• Executive summary (2 to 3 pages).
• Top red flags (3 to 5, with quantification and SPA implication).
• QoE bridge (1 page summary, 4 to 6 pages detail).
• Working capital analysis with target (3 to 5 pages).
• Net debt and debt-like items schedule (2 to 4 pages).
• Detailed findings register (10 to 20 pages, in fixed grammar per issue).
• Tax, legal, commercial interface notes (5 to 10 pages).
• Appendices (data tables, calculations, working files in linked workbooks).

Total length: 35 to 60 pages. Anything longer is padding; anything shorter has skipped something.

9. Closing thoughts.

The single most under-valued attribute of a useful FDD is restraint. The temptation in diligence is to list everything, to make the report look thorough. The actual job is to identify the three or four things that change the deal and to make sure the buyer sees them, with quantification, on page two.

Internal audit produces this discipline naturally. The investigative method - walk-throughs, full-population analytics, root-cause analysis, fixed-grammar findings - is exactly what FDD demands. That is why we run FDD as a natural extension of our internal-audit practice, and why our FDD reports look more like working papers than marketing material.

For a conversation about scoping a buy-side, sell-side or pre-IPO due diligence, write to info@dsomani.in.

CA Dheeraj Somani

Founder & Proprietor · D Somani & Associates · More about the firm →