Financial Due Diligence Terminology Explained

Introduction

Financial Due Diligence goes far beyond traditional accounting definitions. For professionals aspiring to work in transaction advisory, private equity, investment banking, or Big 4 FDD teams, understanding deal-side terminology is critical. Unlike audits, FDD focuses on economic reality, sustainability of earnings, working capital behavior, net debt, and valuation impact.
This blog provides a structured glossary of essential Financial Due Diligence terms commonly used during live deals, management discussions, and investment committee reviews. It is designed for CA students, finance professionals, and career switchers who want to think like investors, identify red flags early, and confidently interpret FDD reports in real-world transactions.

FDD Terminology 

Financial Fundamentals
• Revenue – Total income generated from selling goods or services.
• EBITDA – Earnings before interest, tax, depreciation and amortisation; proxy for operating profitability.
• Adjusted EBITDA – EBITDA corrected for one-off, non-recurring or abnormal items.
• Net Profit – Profit after all expenses including tax and interest.
• Gross Margin – Profit after deducting cost of goods sold (COGS).
• Operating Margin – Profit earned from core operations as a % of revenue.
• PAT – Profit after tax; bottom-line profit.
• Cash Profit – Profit excluding non-cash expenses like depreciation. 

Working Capital (WC)
• Working Capital – Operating Current assets minus operating current liabilities.
• Normalised Working Capital – WC adjusted to reflect normal business needs.
• Negative Working Capital – When current liabilities exceed current assets.
• WC Adjustment – Change in purchase price due to deviation from agreed or normalized WC level.
• Receivables Aging – Analysis of how long customers take to pay.
• Inventory Aging – Days for inventory to convert to sales.
• Payables Aging – How long a company takes to pay vendors.
• DSO (Days Sales Outstanding) – Days customers take to pay.
• DPO (Days Payable Outstanding) – Days the company takes to pay suppliers.
• DIO (Days Inventory Outstanding) – Days inventory stays before sale.
• Cash Conversion Cycle – Time between paying suppliers and collecting cash. 

Debt & Net Debt
• Debt – Total borrowings including long-term and short-term loans.
• Net Debt – Total debt minus cash and cash equivalents.
• Debt-like Items – Obligations treated like debt in valuation (e.g., unpaid taxes, leases).
• Contingent Liabilities – Possible liabilities depending on future events.
• Intercompany Loans – Loans between group entities.
• Finance Lease – Lease treated as debt on the balance sheet. 

Revenue & Expense Analysis
• Revenue Build-Up – Detailed breakdown of revenue drivers.
• Volume/Mix Analysis – Breakdown of growth by quantity vs price vs mix.
• Customer Concentration – Dependency on few major customers.
• Churn Rate – Customers lost during a period.
• Cohort Analysis – Revenue from specific customer groups over time.
• Cost Structure – Fixed vs variable costs of the business.
• COGS – Direct costs required to produce goods sold.
• Opex (Operating Expenses) – Overheads needed to run the business.
• Run-Rate – Annualized estimate based on current month’s performance.
• Seasonality – Patterns where performance varies by season or period. 

Quality of Earnings (QoE)
• Quality of Earnings – True sustainable operating profitability.
• Non-Recurring Items – One-off incomes/expenses not part of normal operations.
• Normalization Adjustments – Adjustments to remove abnormal impacts.
• Management Adjustments – Adjustments proposed by management for fair EBITDA.
• Earnout Adjustments – Adjustments relating to contingent payment structures. 

Tax & Compliance
• Withholding Tax (WHT) – Tax deducted at source on certain payments.
• Deferred Tax – Future tax impact of timing differences.
• Indirect Taxes – GST, VAT, excise and other consumption taxes.
• Litigation Risk – Open cases that may cause future losses.
• Regulatory Non-Compliance – Breaches in statutory rules impacting valuation. 

Cash Flow
• Free Cash Flow – Cash generated after capex and working capital needs.
• Operating Cash Flow – Cash generated from operating activities.
• Capex – Capital expenditure for long-term assets.
• Maintenance Capex – Minimum capex required to sustain operations.
• Growth Capex – Capex for expansion purposes.

Valuation & SPA Terms
• Purchase Price Adjustment (PPA) – Adjustment in deal price at closing.
• Locked Box Mechanism – Price fixed based on a historical balance sheet date.
• Completion Accounts – Financials prepared on closing date to adjust price.
• Earnout – Additional payment based on future performance.
• Working Capital Peg – Agreed WC target used for price adjustment.
• Escrow – Money held by third party until conditions are met.
• Indemnity – Protection against specific losses post-transaction. 

Operational KPIs
• Conversion Ratio – How efficiently inputs (leads, inventory) convert to output.
• ARPU – Average revenue per user.
• Utilization Rate – How effectively assets or labour are used.
• Throughput – Output per unit of time.
• Fulfillment Rate – Percentage of orders fulfilled without issues.

In practice, strong internal audit understanding helps explain why control weaknesses, inefficient processes, and working capital leakages repeatedly surface during FDD—areas that internal audit-focused learning like Master Blaster of Internal Audit helps professionals assess more sharply.

 Subsidiary / Ownership Concepts
• Minority Interest – Portion of a subsidiary not owned by the parent.
• Consolidation – Combining financials of subsidiaries with the parent.
• NCI Adjustments – Adjustments for Non-Controlling Interest in valuation. 

Risk & Red Flags
• Going Concern Risk – Risk business cannot meet future obligations.
• Fraud Indicators – Signs pointing to misstatements or manipulation.
• Control Weakness – Gaps in internal financial processes.
• Related Party Transactions – Business dealings with group entities or owners.
• Off-Balance Sheet Items – Obligations not recorded in books but still relevant (like Operating rent).

Many of these red flags and fraud indicators become far easier to spot when professionals are trained to investigate beyond surface-level numbers, a mindset typically developed through structured learning such as Master Blaster of Forensic Accounting and Investigation.

Conclusion

Mastering Financial Due Diligence terminology is not about memorizing definitions—it is about understanding how each concept impacts valuation, deal structure, and investment decisions. Terms like normalized working capital, quality of earnings, net debt, and purchase price adjustments form the foundation of every transaction discussion.

For students and professionals aiming to move into FDD or transaction advisory roles, clarity on these concepts helps bridge the gap between accounting knowledge and deal execution. When you understand how numbers translate into risks, negotiations, and outcomes, you stop thinking like a bookkeeper and start thinking like a decision-maker—exactly what Financial Due Diligence demands.

Reference Links

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

Financial Due Diligence Interview Questions Explained