All About Financial Due Diligence (FDD): A Complete Guide

Introduction

When Walmart decided to buy Flipkart in 2018 for a whopping ₹1.2 lakh crore ($16 billion), they didn't just sign the cheque blindly. They spent months going through Flipkart's financial records with a fine-tooth comb. This careful investigation is what we call Financial Due Diligence, or FDD.
Think of it like this: Would you buy a used car without checking the engine, brakes, and paperwork? Of course not! Similarly, before businesses invest millions or merge with another company, they need to know exactly what they're getting into. That's where FDD comes in.

What is Financial Due Diligence (FDD)?
Financial Due Diligence is basically a detailed health check-up of a company's finances before any big business deal. Just like you'd get a medical check-up before buying health insurance, companies get their finances examined before mergers, acquisitions, or investments.
In simple words, it's the process of investigating whether a company's financial statements tell the true story. Are they really making the profits they claim? Do they have hidden debts? Are their customers paying on time? FDD answers all these questions.

Why is FDD Important for Businesses?
India's business environment is unique. We have complex GST regulations, multiple compliance requirements under Companies Act and SEBI, and a mix of organized and unorganized sectors. This makes FDD even more critical here.

Let me share why FDD matters:
Prevents Nasty Surprises Imagine buying a company only to discover later that they have unpaid GST dues of crores or pending legal cases. FDD helps uncover such hidden problems before it's too late.
Helps in Correct Valuation Is the company really worth ₹100 crores or is it inflating its numbers? FDD helps determine the actual value, ensuring you don't overpay.
Builds Trust When investors see a thorough FDD report, they gain confidence. For startups raising funds, a clean FDD can be the difference between getting investment or being rejected.
Ensure Compliance With FEMA, MCA, SEBI, and RBI regulations constantly evolving, FDD checks whether the company is following all the rules. This is particularly important in India where regulatory compliance is complex.

With deal activity increasing across India, financial due diligence is quickly becoming a core skill for CAs and finance professionals who want to move into transaction advisory and investment-related roles. Keeping this in mind, a structured and practical learning path focused entirely on deal-driven financial analysis is being introduced through the upcoming Master Blaster of Financial Due Diligence

When Do You Need Financial Due Diligence?
FDD isn't needed for every small transaction. Here are situations where it's essential:

Mergers and Acquisitions
When Company A wants to buy Company B, FDD is mandatory. Remember the Walmart-Flipkart deal? Walmart hired global firms like KPMG to conduct thorough due diligence before finalizing the acquisition.
Private Equity Investments
When PE firms invest crores in startups, they conduct detailed FDD. They want to know if the startup's growth story is real or just on paper.
Bank Loans
When companies apply for large loans, banks often require FDD to assess whether the business can repay the money.
IPO Preparation
Before going public, companies undergo extensive FDD to ensure their financials can withstand scrutiny from SEBI and public investors.

What Does FDD Actually Examine?
Think of FDD as a complete investigation covering multiple areas. Let me break it down:

Financial Statements Analysis
This is the starting point. Experts review:

• Balance sheets for the past 3-5 years
• Profit and loss statements
• Cash flow statements
• Tax returns and GST filings

They're looking for patterns. Is revenue growing steadily or fluctuating wildly? Are expenses reasonable or suspiciously high?

Quality of Earnings
This might sound technical, but it's simple. It means checking if the profits are real and sustainable. For example, if a company shows ₹10 crore profit, but ₹8 crores profit came from selling an old factory building, that's a one-time gain, not regular business profit.

Working Capital
This examines day-to-day finances. What is normal working capital required to run the business? Can the company pay its suppliers on time? Do customers pay their bills promptly? If a company is always running short of cash despite showing profits, there's a problem.

Debt Analysis
How much loan does the company have? Can it repay on time? What are the interest rates? Indian companies often have multiple loans from different banks, and FDD tracks all of them.

Customer and Revenue Concentration
Here's a critical question: Does the company depend on just one or two big customers for most of its revenue? If yes, that's risky. If one customer leaves, the whole business could collapse.
For instance, if a textile manufacturer gets 80% of its orders from one garment brand, that's a red flag.

Compliance Check if required by engagement letter
This is particularly important in India. The FDD team verifies:

• Are all GST returns filed correctly?
• Are PAN, TAN, and other registrations in order?
• Is the company complying with PF, ESIC, and labor laws?
• Are there any notices from income tax or regulatory authorities?

One case that highlights the importance of due diligence is the Supreme Court ruling in Nirma Industries vs. SEBI. The court clearly stated that investor companies must conduct proper due diligence as per SEBI regulations before making investments. Skipping this step can have serious legal consequences.

The FDD Process: Step by Step
Let me walk you through how FDD typically works in India:

Step 1: Planning The buyer or investor decides what they need to examine. For a tech startup, they might focus on intellectual property and customer contracts. For a manufacturing company, they'd look at inventory and production costs.

Step 2: Information Gathering
This is where the target company submits documents. Common documents include:

• Last 3 years of audited financial statements
• Monthly MIS reports
• List of all assets and liabilities
• All general ledger
• Customer contracts and vendor agreements
• Employee salary records
• All tax returns and GST filings
• Bank statements and loan documents

Step 3: Analysis
Now the real work begins. Financial experts, often from firms like Deloitte, EY, KPMG, or PwC, analyze everything. They create detailed models, compare trends, and identify red flags.

Step 4: Site Visits
Sometimes, the FDD team visits the company's offices, factories, or warehouses. This helps verify if the assets really exist and are in good condition.

Step 5: Management Discussions
The FDD team interviews the company's management. They ask tough questions about revenue patterns, expenses, future plans, and any concerns they've spotted.

Step 6: Quality of Earnings Analysis
Beyond reported profits, the FDD team checks whether earnings are sustainable. For example, if a company shows a sudden profit jump due to one-time government subsidy or asset sale, that income may not continue post-acquisition. The team adjusts EBITDA to reflect true operating performance.

Step 7: Working Capital Assessment
Here, the team evaluates whether the business can run smoothly after acquisition. Key areas reviewed include:

• Debtors ageing and collection cycles
• Inventory turnover and slow-moving stock
• Creditor payment patterns

For instance, rising receivables without matching sales growth may indicate future cash flow stress.

Step 8: Debt and Off-Balance-Sheet Review
The FDD team looks for hidden liabilities such as undisclosed loans, guarantees, lease commitments, or pending litigation. For example, a manufacturing company may have provided corporate guarantees to group entities that do not appear clearly in the balance sheet.

Step 9: Tax and Regulatory Exposure Review
Although tax diligence is often a separate exercise, financial due diligence flags major tax risks. This includes unpaid GST, disputed income tax demands, non-compliance with TDS, or exposure under labour laws. For example, incorrect GST classification can lead to future penalties that impact deal valuation.

Step 10: Related Party Transaction Analysis
Transactions with promoters or group entities are examined closely:

• Pricing compared with market rates
• Nature and frequency of transactions
• Dependency on related parties

For instance, excessive payments to promoter-owned vendors may inflate costs artificially.

Step 11: Report Preparation
Finally, a comprehensive FDD report is prepared. This includes:

• Summary of key findings
• Identified risks and red flags
• Adjusted financial statements (correcting any errors or one-time items)
• Recommendations for the deal

Step 12: Deal Impact and Negotiation Support
Finally, FDD findings influence how the deal is structured:

• Purchase price adjustments
• Escrow or holdback arrangements
• Indemnity clauses for identified risks

For example, doubtful receivables may lead to part of the deal value being retained until collections are confirmed.

Example: The Flipkart Story

Let's revisit the Walmart-Flipkart deal, which is one of India's biggest FDD exercises.

When Walmart showed interest in buying Flipkart, they conducted extensive due diligence over several months. They examined:

• Flipkart's revenue from different categories (mobile phones, fashion, electronics)
• Its losses and cash burn rate
• Logistics network and warehousing costs
• Legal compliance with Indian FDI regulations
• Competition from Amazon India
• Myntra and PhonePe (companies owned by Flipkart)

The deal involved multiple law firms and accounting firms. After completing FDD, Walmart discovered both opportunities and challenges. They valued Flipkart at approximately $20 billion and decided to acquire a 77% stake for $16 billion.

Interestingly, some investors like SoftBank, who had invested just months earlier, made huge profits by selling their shares to Walmart. This was possible because the FDD process validated Flipkart's value and future potential.

How is FDD Different from a Regular Audit?
Many people confuse FDD with financial audits, but they're different:
Regular Audit: It's like a routine medical check-up. Auditors verify if the financial statements are prepared correctly and follow accounting standards. It's mandatory for companies.
FDD: It's like a specialist consultation before surgery. FDD goes much deeper, investigates specific concerns, and focuses on helping investors make decisions. It's not mandatory but done for specific transactions.
Think of it this way: An audit tells you if the patient is generally healthy. FDD tells you if the patient can survive a specific operation (the business deal).

A strong foundation in statutory audit also plays a crucial role in FDD, because understanding audit procedures, assertions, and documentation standards makes it easier to analyse financial statements critically—something that becomes second nature through focused learning such as Master Blaster of Statutory Audit.

Common Red Flags Found During FDD

Based on experience from Indian deals, here are warning signs that FDD often uncovers:
Inflated Revenue Some companies book sales that haven't actually happened or include fake invoices to show higher numbers.
Hidden Liabilities Undisclosed loans, pending legal cases, or tax disputes that aren't shown in the balance sheet.
Irregular Expenses When salary expenses are higher than industry standards or marketing costs seem unreasonably high without corresponding results.
Related Party Transactions Money flowing between the company and its promoters or their family members without proper documentation.
GST and Tax Issues Missing returns, pending assessments, or mismatches between GSTR-1 and GSTR-3B.

Many professionals who move into forensic accounting roles later realize how closely forensic investigation skills overlap with financial due diligence, especially when it comes to identifying hidden liabilities, related party transactions, and revenue manipulation—areas that are deeply explored in structured programs like Master Blaster of Forensic Accounting and Investigation.

How to Prepare Your Company for FDD

If you're a startup or business owner expecting FDD, here's how to prepare:
Keep Records Updated Maintain digital copies of all financial documents. Use accounting software like Tally, Zoho Books, or QuickBooks. Don't rely on manual registers.
Reconcile Everything Your bank statements should match your books. GST returns should align with your sales data. Fix any mismatches immediately.
Be Transparent Don't hide problems. If there's a legal case or a one-time loss, disclose it upfront. Investors appreciate honesty more than discovering issues later.
Organize Documents Create a systematic filing system. When the FDD team asks for information, you should be able to provide it within hours, not days.
Get a Pre-FDD Review Consider hiring a CA firm to do a mock FDD before the actual one. They'll identify weak spots that you can fix in advance.

Final Thoughts

Financial Due Diligence is not just a formality—it's a crucial safeguard in business transactions. Whether you're an investor putting money into a company or an entrepreneur raising funds, understanding FDD helps you make informed decisions.
The Indian business landscape is growing rapidly. More startups are raising funds, more acquisitions are happening, and more companies are going public. In this environment, FDD has become more important than ever.
Remember the golden rule: Never invest millions without knowing exactly what you're buying. And if you're raising money, be prepared to show that your business is as good as you claim. That's what FDD is all about—trust, but verify.
If you're planning any major business transaction, don't skip the FDD. Yes, it takes time and costs money, but it's far cheaper than discovering problems after the deal is done. As they say in business, "An ounce of prevention is worth a pound of cure."

Frequently Asked Questions

1. What is Financial Due Diligence and why is it important in India?
Financial Due Diligence is a detailed review of a company’s financial health before a major transaction like an acquisition, investment, or IPO. In India, FDD is especially important due to complex GST laws, tax regulations, and compliance requirements. It helps identify hidden liabilities, incorrect reporting, and valuation risks before a deal is finalized. 

2. How is Financial Due Diligence different from a statutory audit?
A statutory audit focuses on whether financial statements comply with accounting standards and legal requirements. Financial Due Diligence goes beyond compliance and analyzes business sustainability, quality of earnings, working capital needs, and deal-related risks. FDD is decision-driven, while audits are compliance-driven. 

3. What skills are required to build a career in Financial Due Diligence?
A career in Financial Due Diligence requires strong financial statement analysis, understanding of working capital, ability to identify red flags, business interpretation skills, and structured reporting. Professionals often transition into FDD from audit, accounting, or finance roles by developing a deal-oriented mindset.